Tight fiscal policy by local, state, and federal governments held down economic growth for more than four years, but that restraint finally appears to be over, the latest reading from the Hutchins Center on Fiscal and Monetary Policy’s Fiscal Impact Measure shows.

The Fiscal Impact Measure estimates the effect of federal, state and local spending and taxes on inflation-adjusted growth in the Gross Domestic Product (GDP.) As the chart below illustrates, the Fiscal Impact Measure has three major components: spending by the federal government (dark blue bars), spending by state and local governments (light blue bars), and taxes and transfers at all levels of government combined (green bars).

This quarter’s data reinforce the view that the fiscal headwinds are finally behind us. Local, state, and federal fiscal policy contributed just over two-tenths of a percentage point (0.22 points) to real GDP growth in the second quarter, which came in at an annual rate of 2.3 percent. Overall, fiscal policies have been about neutral (zero) over the past year. Fiscal policy is no longer a source of contraction for the economy, but neither is it a source of strength.

The recovery in state and local spending appears quite modest. Spending fell sharply in 2009 and continued to decline through mid-2013. But state and local governments still appear very cautious about hiring and investment. In the second quarter of this year, spending jumped sharply, but that followed a weak first quarter that was likely affected by weather. Over the past year, the positive contribution of state and local governments to GDP growth has averaged one-tenth of a percentage point, while GDP growth averaged 2.3 percent.

Federal spending was also a source of contraction in recent years, reflecting the end of spending increases and tax breaks initiated by President Obama and Congress during the worst of the recession, as well as tight caps on annually appropriated spending and the automatic spending cuts known as sequestration. All told, federal spending lowered real GDP growth by an average of 0.35 percentage points per year between 2011 and 2013. Over the past year, real federal spending has been about unchanged, neither adding to nor subtracting from real GDP growth. Similarly, taxes and transfers at all levels of government have been a roughly neutral factor in recent quarters.

The Hutchins Center’s Fiscal Impact Measure (FIM) is a gauge of the contribution of federal, state, and local fiscal policy to near-term changes in the gross domestic product, the tally of all the goods and services produced in the economy. It includes both the direct effects of government purchases as well as the more indirect effects of government taxes and government transfers. When FIM is positive, the government is contributing to real GDP growth, and when it is negative, it is subtracting from it. For more on what goes into FIM and how it’s calculated, see here. The FIM is updated after each new government estimate of GDP.

Authors

Tight fiscal policy by local, state, and federal governments held down economic growth for more than four years, but that restraint finally appears to be over, the latest reading from the Hutchins Center on Fiscal and Monetary Policy’s Fiscal Impact Measure shows.

The Fiscal Impact Measure estimates the effect of federal, state and local spending and taxes on inflation-adjusted growth in the Gross Domestic Product (GDP.) As the chart below illustrates, the Fiscal Impact Measure has three major components: spending by the federal government (dark blue bars), spending by state and local governments (light blue bars), and taxes and transfers at all levels of government combined (green bars).

This quarter’s data reinforce the view that the fiscal headwinds are finally behind us. Local, state, and federal fiscal policy contributed just over two-tenths of a percentage point (0.22 points) to real GDP growth in the second quarter, which came in at an annual rate of 2.3 percent. Overall, fiscal policies have been about neutral (zero) over the past year. Fiscal policy is no longer a source of contraction for the economy, but neither is it a source of strength.

The recovery in state and local spending appears quite modest. Spending fell sharply in 2009 and continued to decline through mid-2013. But state and local governments still appear very cautious about hiring and investment. In the second quarter of this year, spending jumped sharply, but that followed a weak first quarter that was likely affected by weather. Over the past year, the positive contribution of state and local governments to GDP growth has averaged one-tenth of a percentage point, while GDP growth averaged 2.3 percent.

Federal spending was also a source of contraction in recent years, reflecting the end of spending increases and tax breaks initiated by President Obama and Congress during the worst of the recession, as well as tight caps on annually appropriated spending and the automatic spending cuts known as sequestration. All told, federal spending lowered real GDP growth by an average of 0.35 percentage points per year between 2011 and 2013. Over the past year, real federal spending has been about unchanged, neither adding to nor subtracting from real GDP growth. Similarly, taxes and transfers at all levels of government have been a roughly neutral factor in recent quarters.

The Hutchins Center’s Fiscal Impact Measure (FIM) is a gauge of the contribution of federal, state, and local fiscal policy to near-term changes in the gross domestic product, the tally of all the goods and services produced in the economy. It includes both the direct effects of government purchases as well as the more indirect effects of government taxes and government transfers. When FIM is positive, the government is contributing to real GDP growth, and when it is negative, it is subtracting from it. For more on what goes into FIM and how it’s calculated, see here. The FIM is updated after each new government estimate of GDP.

In some parts of the country, many employers will be very reluctant to pay high wages to workers with modest skills.

When labor unions and activists began calling for an increase in America’s minimum wage to $15 an hour, many thought it was a typical bargaining ploy, and that they would be pleased to receive much more modest increases. In 2013, the Obama Administration proposed a modest increase, whereby the federal minimum wage would rise to $9 an hour from $7.25 an hour. They increased the proposal to $10 an hour the following year, and also called for indexing it to inflation.

Like many labor economists, I supported both of these proposals, and I continue to support the latter one.

Lately, however, minimum wages have risen too high to $15 an hour in some cities. Seattle was the first major jurisdiction to do so in 2014; San Francisco and Los Angeles followed. Earlier this month, New York raised its minimum wage to $15 for its fast-food workers, while the University of California plans to do the same for its low-wage employees. Now, the Washington, D.C. City Council will be considering such an increase.

Many economists worry minimum wage increases tend to reduce employment, hurting young and less-educated workers the most. And they have analyzed the effects of state and federal increases in the U.S. and other countries in hundreds of statistical studies. Some credible studies find moderate negative effects while others find none; our best guess is that moderate minimum wage increases will lead to modest job losses. In a Congressional Budget Office report last year, policy analysts predicted that Obama’s proposal to raise the federal minimum wage to $10 an hour would raise wages for 16 to 24 million people while eliminating about half a million jobs – a reasonable tradeoff worth embracing, in my view.

But I have much more serious worries about a $15 an hour minimum wage, which constitutes a wage increase of 50% to 100% in most places (even after adjusting for inflation). In cities like Seattle, with a relatively more educated workforce and dynamic labor market, it might be a gamble worth taking. But in other cities, such as L.A. and Washington, D.C. – with their large populations of less-educated workers, including unskilled immigrants – such increases are extremely risky.

In job markets where young or less-educated workers already have difficulty finding jobs and gaining important work experience, such mandates will likely make it much harder.

In a city like Washington D.C. where unemployment among those with a high school education or less is at a worrisome 15%, jobless rates will almost certainly rise. Many employers will be very reluctant to pay high wages to workers whose skills – including the ability to speak English, in the case of many immigrants – are so modest. A likely result would be not only increases in unemployment but also drops in formal labor force activity (where workers work or search for legal jobs) and perhaps some growth in undocumented work among immigrants.

Three additional points reinforce these concerns for me. First, the increases up to $15 are much greater in magnitude than anything we have studied in the past; because of this, it’s hard to say if the previous research that found modest negative effects on employment would hold true, and a reasonable guess is that the effects now will be much more negative.

Second, state and especially local increases of this magnitude will generate big incentives for employers to move across local borders, especially from central cities to suburbs. For instance, if Washington, D.C. raises its minimum to $15 (after it is already scheduled to rise to $11.50 in 2016) while Arlington, Virginia remains at $7.25, the incentives for employers with many low-wage workers to shift places of business from the former to the latter will be quite strong. This wage increase might be the straw that breaks the camel’s back for many D.C. businesses, who are now also faced with new hiring regulations, such as mandated paid leave and prohibitions on criminal record checking in applications, or marijuana screening, and perhaps on credit checks.

Third, it might take time for employers of many low-skill workers to learn how to economize on their labor costs, but they will over time, since the incentives to do so are much larger – and that would be bad news for the very low-skill workers the higher minimum wage is designed to help. For instance, fast-food workers might be more easily replaced by robots. Hotels may reduce their tendency to automatically clean the rooms of their guests, and may charge extra for doing so. In the state of New York, fast-food franchises will probably be replaced by other kinds of restaurants and food services. Employers in these industries will also likely demand better education, skills and experience among those whom they hire.

None of this suggests that the crisis of low wages for American workers isn’t serious. But there is no silver bullet — raising the minimum wage alone won’t solve it. Our toolkit should contain a range of sensible approaches. Congress should pass a sensible and moderate Federal increase in the minimum wage. We should also expand the Earned Income Tax Credits for childless adults, paid parental leave (funded by payroll taxes rather than mandates on employers), and education and training efforts for workers with low skills to better prepare them for good-paying jobs. We should work with employers to help them expand apprenticeships and other opportunities for workers to “learn while they earn,” and to generate better pathways from high school and community colleges into high-paying jobs.

Trying to accomplish this by simply making 15 the new 10, in terms of minimum wage increases, could potentially generate more harm than good.

Authors

In some parts of the country, many employers will be very reluctant to pay high wages to workers with modest skills.

When labor unions and activists began calling for an increase in America’s minimum wage to $15 an hour, many thought it was a typical bargaining ploy, and that they would be pleased to receive much more modest increases. In 2013, the Obama Administration proposed a modest increase, whereby the federal minimum wage would rise to $9 an hour from $7.25 an hour. They increased the proposal to $10 an hour the following year, and also called for indexing it to inflation.

Like many labor economists, I supported both of these proposals, and I continue to support the latter one.

Lately, however, minimum wages have risen too high to $15 an hour in some cities. Seattle was the first major jurisdiction to do so in 2014; San Francisco and Los Angeles followed. Earlier this month, New York raised its minimum wage to $15 for its fast-food workers, while the University of California plans to do the same for its low-wage employees. Now, the Washington, D.C. City Council will be considering such an increase.

Many economists worry minimum wage increases tend to reduce employment, hurting young and less-educated workers the most. And they have analyzed the effects of state and federal increases in the U.S. and other countries in hundreds of statistical studies. Some credible studies find moderate negative effects while others find none; our best guess is that moderate minimum wage increases will lead to modest job losses. In a Congressional Budget Office report last year, policy analysts predicted that Obama’s proposal to raise the federal minimum wage to $10 an hour would raise wages for 16 to 24 million people while eliminating about half a million jobs – a reasonable tradeoff worth embracing, in my view.

But I have much more serious worries about a $15 an hour minimum wage, which constitutes a wage increase of 50% to 100% in most places (even after adjusting for inflation). In cities like Seattle, with a relatively more educated workforce and dynamic labor market, it might be a gamble worth taking. But in other cities, such as L.A. and Washington, D.C. – with their large populations of less-educated workers, including unskilled immigrants – such increases are extremely risky.

In job markets where young or less-educated workers already have difficulty finding jobs and gaining important work experience, such mandates will likely make it much harder.

In a city like Washington D.C. where unemployment among those with a high school education or less is at a worrisome 15%, jobless rates will almost certainly rise. Many employers will be very reluctant to pay high wages to workers whose skills – including the ability to speak English, in the case of many immigrants – are so modest. A likely result would be not only increases in unemployment but also drops in formal labor force activity (where workers work or search for legal jobs) and perhaps some growth in undocumented work among immigrants.

Three additional points reinforce these concerns for me. First, the increases up to $15 are much greater in magnitude than anything we have studied in the past; because of this, it’s hard to say if the previous research that found modest negative effects on employment would hold true, and a reasonable guess is that the effects now will be much more negative.

Second, state and especially local increases of this magnitude will generate big incentives for employers to move across local borders, especially from central cities to suburbs. For instance, if Washington, D.C. raises its minimum to $15 (after it is already scheduled to rise to $11.50 in 2016) while Arlington, Virginia remains at $7.25, the incentives for employers with many low-wage workers to shift places of business from the former to the latter will be quite strong. This wage increase might be the straw that breaks the camel’s back for many D.C. businesses, who are now also faced with new hiring regulations, such as mandated paid leave and prohibitions on criminal record checking in applications, or marijuana screening, and perhaps on credit checks.

Third, it might take time for employers of many low-skill workers to learn how to economize on their labor costs, but they will over time, since the incentives to do so are much larger – and that would be bad news for the very low-skill workers the higher minimum wage is designed to help. For instance, fast-food workers might be more easily replaced by robots. Hotels may reduce their tendency to automatically clean the rooms of their guests, and may charge extra for doing so. In the state of New York, fast-food franchises will probably be replaced by other kinds of restaurants and food services. Employers in these industries will also likely demand better education, skills and experience among those whom they hire.

None of this suggests that the crisis of low wages for American workers isn’t serious. But there is no silver bullet — raising the minimum wage alone won’t solve it. Our toolkit should contain a range of sensible approaches. Congress should pass a sensible and moderate Federal increase in the minimum wage. We should also expand the Earned Income Tax Credits for childless adults, paid parental leave (funded by payroll taxes rather than mandates on employers), and education and training efforts for workers with low skills to better prepare them for good-paying jobs. We should work with employers to help them expand apprenticeships and other opportunities for workers to “learn while they earn,” and to generate better pathways from high school and community colleges into high-paying jobs.

Trying to accomplish this by simply making 15 the new 10, in terms of minimum wage increases, could potentially generate more harm than good.

Authors

]]>
http://www.brookings.edu/blogs/up-front/posts/2015/07/30-hutchins-roundup?rssid=economics{1A2E7851-BB35-45DD-80CE-9C7FADC0F580}http://webfeeds.brookings.edu/~/104100934/0/brookingsrss/programs/economics~Hutchins-Roundup-Public-investment-and-elections-impact-of-interest-rate-changes-and-moreHutchins Roundup: Public investment and elections, impact of interest rate changes, and more

Jonathan L. Willis and Guangye Cao of the Kansas City Fed find that, prior to 1985, a 0.25 percentage point reduction in the federal funds rate was associated with a roughly 0.2 percent increase in employment over the following 2 years—255,000 jobs in today’s market—but that the same rate cut today has almost no impact on employment. The authors argue that this is due to a weaker link between short- and long-run interest rates and a general shift in employment from interest rate sensitive industries like manufacturing and construction to less sensitive service providing sectors.

Analyzing data on 80 democracies between 1975 and 2012, Sanjeev Gupta, Estelle Liu, and Carlos Mulas-Granados of the International Monetary Fund find that growth in public investment spending is highest at the beginning of election cycles—peaking roughly 2 years prior to an election. Spending slows as the election approaches and incumbents favor more visible short-term spending. The authors note that political systems with a larger number of parties experience smaller increases in public investment, while left-leaning incumbent parties are associated with larger increases.

Sumit Agarwal of the National University of Singapore and co-authors find that for every $1 increase in credit limits, households with low credit scores increase total borrowing by 58 cents over the ensuing year. Households with high credit scores exhibit no change in total borrowing. In addition, the authors note that reducing the cost of funds for banks has a large positive impact on the credit limits of high credit score households, but only small effects on the credit limits for low credit score households. Together, these findings suggest that policies designed to stimulate household borrowing by expanding bank credit provides the least amount of credit to those who want to borrow most.

The role of the ECB in the Greek crisis has been heavily criticized. Some accuse it of having suffocated the country’s banks, others of having helped them too much. Who is right?

We are the central bank for the 19 countries of the euro area, including Greece. That is our mandate and we have never strayed from it. Since the end of 2014, the amount of liquidity injected into the Greek economy by the Eurosystem has increased from €40 billion to €130 billion. We have taken care that our actions are never a replacement for the political decision-making process. That people are turning to the central bank on issues that demand a political rather than technical response reveals a serious weakness in the institutional functioning of the euro area. This weakness fuels excessive expectations concerning the ECB.

--Benoît Cœuré, Member of the Executive Board of the European Central Bank

Authors

Jonathan L. Willis and Guangye Cao of the Kansas City Fed find that, prior to 1985, a 0.25 percentage point reduction in the federal funds rate was associated with a roughly 0.2 percent increase in employment over the following 2 years—255,000 jobs in today’s market—but that the same rate cut today has almost no impact on employment. The authors argue that this is due to a weaker link between short- and long-run interest rates and a general shift in employment from interest rate sensitive industries like manufacturing and construction to less sensitive service providing sectors.

Analyzing data on 80 democracies between 1975 and 2012, Sanjeev Gupta, Estelle Liu, and Carlos Mulas-Granados of the International Monetary Fund find that growth in public investment spending is highest at the beginning of election cycles—peaking roughly 2 years prior to an election. Spending slows as the election approaches and incumbents favor more visible short-term spending. The authors note that political systems with a larger number of parties experience smaller increases in public investment, while left-leaning incumbent parties are associated with larger increases.

Sumit Agarwal of the National University of Singapore and co-authors find that for every $1 increase in credit limits, households with low credit scores increase total borrowing by 58 cents over the ensuing year. Households with high credit scores exhibit no change in total borrowing. In addition, the authors note that reducing the cost of funds for banks has a large positive impact on the credit limits of high credit score households, but only small effects on the credit limits for low credit score households. Together, these findings suggest that policies designed to stimulate household borrowing by expanding bank credit provides the least amount of credit to those who want to borrow most.

The role of the ECB in the Greek crisis has been heavily criticized. Some accuse it of having suffocated the country’s banks, others of having helped them too much. Who is right?

We are the central bank for the 19 countries of the euro area, including Greece. That is our mandate and we have never strayed from it. Since the end of 2014, the amount of liquidity injected into the Greek economy by the Eurosystem has increased from €40 billion to €130 billion. We have taken care that our actions are never a replacement for the political decision-making process. That people are turning to the central bank on issues that demand a political rather than technical response reveals a serious weakness in the institutional functioning of the euro area. This weakness fuels excessive expectations concerning the ECB.

--Benoît Cœuré, Member of the Executive Board of the European Central Bank

Authors

]]>
http://www.brookings.edu/blogs/social-mobility-memos/posts/2015/07/29-simpsons-paradox-education-earnings-hershbein?rssid=economics{A69B59A0-E787-4D33-BAA3-E87C23E38AB2}http://webfeeds.brookings.edu/~/103948804/0/brookingsrss/programs/economics~When-average-isnt-good-enough-Simpsons-paradox-in-education-and-earningsWhen average isn't good enough: Simpson's paradox in education and earnings

In the early 1970s, the University of California, Berkeley was sued for gender discrimination over admission to graduate school. Of the 8,442 male applicants for the fall of 1973, 44 percent were admitted, but only 35 percent of the 4,351 female applicants were accepted. At first blush, and assuming the applicants’ qualifications were similar, this pattern indeed appeared consistent with gender discrimination. However, when researchers looked more closely within specific departments, this bias against women went away, and even reversed in several cases.

This apparent contradiction, in which the trend of the whole can be different from or the opposite of the trend of the constituent parts, is often called Simpson’s paradox, after British statistician Edward H. Simpson, who described the phenomenon in 1951. In the Berkeley case, the “paradox” occurred because women disproportionately applied to departments with low acceptance rates, as shown in the table above, while men disproportionately applied to departments with high acceptance rates. Examples of Simpson’s paradox have also been found in baseball batting averages, on-time flights of airlines, and even survival rates from the Titanic.

Simpson’s paradox and math results

Why might the paradox matter for research or policy? Education is a case in point. According the National Assessment of Educational Progress (NAEP), the only nationally-representative exam measuring student learning over the past few decades, math scores for all 17-year-olds barely budged between 1992 and 2012. In fact, the average score dipped by a point (see the navy blue line below):

But as the graph also shows, average test scores actually rose slightly for white students, black students, and Hispanic students. If each of these groups was performing better, how did the overall average go down? The answer is the composition of students changed. In 1992, 75 percent of students were white, 15 percent were black, and 7 percent was Hispanic. By 2012, 57 percent were white, 13 percent were black, and 22 percent were Hispanic. The modest progress in each ethnic group is not visible in the overall results, since black and Hispanic students have lower average scores.

Simpson’s paradox and median earnings

Another example is the anemic trend in median earnings among prime-age men. Although the lack of growth in earnings for most men is real, the picture is not quite as bad as it first appears. Between the bottom of the early 1980s recession in 1982 up to 2013, inflation-adjusted median earnings of men aged 25 through 44 fell by about $1,000, from $34,000 to $33,000. However, the same earnings measure rose by more than $3,000 for white men, increased just under $1,000 for black men, stayed flat for Hispanic men, and shot up by $10,000 for other men (mostly Asians). Except for those of this last category, these changes are hardly something to crow about, but they’re better than a $1,000 decline.

Once again, the reason for the discrepancy is changing composition of the population: there are now more men in the lower-earning racial categories.

As our society grows more diverse, Simpson’s paradox may make more frequent appearances. Scholars and policy-makers will have to be mindful as they examine long-term changes of social and economic progress. It would be a shame if real progress in these areas was overlooked because of a naïve reliance on single averages.

Authors

In the early 1970s, the University of California, Berkeley was sued for gender discrimination over admission to graduate school. Of the 8,442 male applicants for the fall of 1973, 44 percent were admitted, but only 35 percent of the 4,351 female applicants were accepted. At first blush, and assuming the applicants’ qualifications were similar, this pattern indeed appeared consistent with gender discrimination. However, when researchers looked more closely within specific departments, this bias against women went away, and even reversed in several cases.

This apparent contradiction, in which the trend of the whole can be different from or the opposite of the trend of the constituent parts, is often called Simpson’s paradox, after British statistician Edward H. Simpson, who described the phenomenon in 1951. In the Berkeley case, the “paradox” occurred because women disproportionately applied to departments with low acceptance rates, as shown in the table above, while men disproportionately applied to departments with high acceptance rates. Examples of Simpson’s paradox have also been found in baseball batting averages, on-time flights of airlines, and even survival rates from the Titanic.

Simpson’s paradox and math results

Why might the paradox matter for research or policy? Education is a case in point. According the National Assessment of Educational Progress (NAEP), the only nationally-representative exam measuring student learning over the past few decades, math scores for all 17-year-olds barely budged between 1992 and 2012. In fact, the average score dipped by a point (see the navy blue line below):

But as the graph also shows, average test scores actually rose slightly for white students, black students, and Hispanic students. If each of these groups was performing better, how did the overall average go down? The answer is the composition of students changed. In 1992, 75 percent of students were white, 15 percent were black, and 7 percent was Hispanic. By 2012, 57 percent were white, 13 percent were black, and 22 percent were Hispanic. The modest progress in each ethnic group is not visible in the overall results, since black and Hispanic students have lower average scores.

Simpson’s paradox and median earnings

Another example is the anemic trend in median earnings among prime-age men. Although the lack of growth in earnings for most men is real, the picture is not quite as bad as it first appears. Between the bottom of the early 1980s recession in 1982 up to 2013, inflation-adjusted median earnings of men aged 25 through 44 fell by about $1,000, from $34,000 to $33,000. However, the same earnings measure rose by more than $3,000 for white men, increased just under $1,000 for black men, stayed flat for Hispanic men, and shot up by $10,000 for other men (mostly Asians). Except for those of this last category, these changes are hardly something to crow about, but they’re better than a $1,000 decline.

Once again, the reason for the discrepancy is changing composition of the population: there are now more men in the lower-earning racial categories.

As our society grows more diverse, Simpson’s paradox may make more frequent appearances. Scholars and policy-makers will have to be mindful as they examine long-term changes of social and economic progress. It would be a shame if real progress in these areas was overlooked because of a naïve reliance on single averages.

Authors

]]>
http://www.brookings.edu/blogs/jobs/posts/2015/07/30-july-job-projection-barnichon?rssid=economics{E70E5CAF-2FCA-481C-8924-267C1BBCF7BD}http://webfeeds.brookings.edu/~/103980956/0/brookingsrss/programs/economics~Unemployment-projected-to-drop-to-in-July-and-reach-by-DecemberUnemployment projected to drop to 5.2% in July and reach 4.5% by December

This post discusses my monthly update of the Barnichon-Nekarda model. For an introduction to the basic concepts used in this post, read my introductory post (Full details are available here.)

In June, the unemployment rate dropped by 20 basis points to reach 5.3 percent. The model had been anticipating this strong decline in unemployment for a few months now, and this drop comports with the model in its reading of recent unemployment dynamics. Consequently, the contour of the forecast remains unchanged, and the model expects unemployment to decline steadily over the coming months. The model predicts a jobless rate of 5.2 percent for July, reaching 4.5 percent by the end of the year.

The model’s forecast can be easily understood by looking at the projected behavior of the “steady-state” unemployment rate -- the rate of unemployment implied by the underlying labor force flows (the blue line in figure 2) stands currently at 4.7 percent, 0.5 percentage points lower than the actual unemployment rate. Our research shows that the actual unemployment rate converges toward this steady state. With the steady-state unemployment rate lower than the actual rate, this "steady-state convergence dynamic" will push the unemployment rate down strongly, implying a steady decline in unemployment going forward.

To forecast the behavior of steady-state unemployment, the model propagates forward its best estimate of how the flows in and out of unemployment will evolve over time. Following months of good news on the job openings front, the model anticipates strong growth in the job finding rate (U to E) over the next few months (figure 4), which will push down the steady-state unemployment rate, and will lead to a steady decline in the unemployment rate strongly over the next 6 months.

To read more about the underlying model and the evidence that it outperforms other unemployment rate forecasts, see Barnichon and Nekarda (2012).

Authors

This post discusses my monthly update of the Barnichon-Nekarda model. For an introduction to the basic concepts used in this post, read my introductory post (Full details are available here.)

In June, the unemployment rate dropped by 20 basis points to reach 5.3 percent. The model had been anticipating this strong decline in unemployment for a few months now, and this drop comports with the model in its reading of recent unemployment dynamics. Consequently, the contour of the forecast remains unchanged, and the model expects unemployment to decline steadily over the coming months. The model predicts a jobless rate of 5.2 percent for July, reaching 4.5 percent by the end of the year.

The model’s forecast can be easily understood by looking at the projected behavior of the “steady-state” unemployment rate -- the rate of unemployment implied by the underlying labor force flows (the blue line in figure 2) stands currently at 4.7 percent, 0.5 percentage points lower than the actual unemployment rate. Our research shows that the actual unemployment rate converges toward this steady state. With the steady-state unemployment rate lower than the actual rate, this "steady-state convergence dynamic" will push the unemployment rate down strongly, implying a steady decline in unemployment going forward.

To forecast the behavior of steady-state unemployment, the model propagates forward its best estimate of how the flows in and out of unemployment will evolve over time. Following months of good news on the job openings front, the model anticipates strong growth in the job finding rate (U to E) over the next few months (figure 4), which will push down the steady-state unemployment rate, and will lead to a steady decline in the unemployment rate strongly over the next 6 months.

To read more about the underlying model and the evidence that it outperforms other unemployment rate forecasts, see Barnichon and Nekarda (2012).

Authors

]]>
http://www.brookings.edu/research/papers/2015/07/29-best-interest-retirement-savers?rssid=economics{392D4046-BCE9-48EA-8F58-728A3830889A}http://webfeeds.brookings.edu/~/103959838/0/brookingsrss/programs/economics~Serving-the-best-interests-of-retirement-savers-Framing-the-issuesServing the best interests of retirement savers: Framing the issues

Americans are enjoying longer lifespans than ever before. Living longer affords individuals the opportunity to make more contributions to the world, to spend more time with their loved ones, and to devote more years to their favorite activities – but a longer life, and particularly a longer retirement, is also expensive. The retirement security landscape is evolving as workers, employers, retirees, and financial services companies find their needs shifting. Once, many workers planned to stay with a single employer for most or all of their careers, building up a sizeable pension and looking forward to a comfortable retirement. Today, workers more and more workers will be employed by many different employers. Additionally, generous defined benefit (DB) retirement plans are less popular than they once were – though they were never truly commonplace – and defined contribution (DC) plans are becoming ever more prevalent.

Figure 1, below, shows the change from DB to DC that has occurred over the past three decades.

In the past many retirees struggled financially towards the end of their lives, just as they do now, but even so, the changes to the retirement security landscape have been real and marked, and have had a serious impact on workers and retirees alike. DB plans are dwindling, DC plans are on the rise, and as a result individuals must now take a more active role in managing their retirement savings. DC plans incorporate contributions from employees and employers alike, and workers much choose how to invest their nest egg. When a worker leaves a job for retirement or for a different job he or she will often roll over the money from a 401(k) plan into an Individual Retirement Account (IRA). While having more control over one’s retirement funds might seem on its face to be a net improvement, the reality is that the average American lacks the financial literacy to make sound decisions (SEC 2012).

The Council of Economic Advisers (CEA) expressed concern earlier this year that savers with IRA accounts may receive poor investment advice, particularly in cases where their financial advisors are compensated through fees and commissions. “[The] best recommendation for the saver may not be the best recommendation for the adviser’s bottom line” (CEA 2015). President Obama echoed these concerns in a speech at AARP in February, asking the Department of Labor (DoL) to update its rules for financial advisors to follow when handling IRA accounts (White House 2015). The DoL receives its authority to craft such rules and requirements from the 1974 Employee Retirement Income Security Act (ERISA) (DoL 2015a).

The DoL recently proposed a regulation designed to increase consumer protection by treating some investment advisors as fiduciaries under ERISA and the 1986 Internal Revenue Code (DoL 2015b). The proposed rule has generated heated debate, and some financial advisors have responded with great concern, arguing that it will be difficult or impossible to comply with the rule without raising costs to consumers and/or abandoning smaller accounts that generate little or no profit. Advisors who have traditionally offered only the proprietary products of a single company worry that the business model they have used for many years will no longer be considered to be serving the best interests of clients.

Rather than offering detailed comments on the DoL proposals, this paper will look more broadly at the problem of saving for retirement and the role for professional advice.This is, of course, a well-travelled road with a large literature by academics, institutions and policy-makers, however, it is worthwhile to think about market failures, lack of information and individual incentives and what they imply for the investment advice market.

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Americans are enjoying longer lifespans than ever before. Living longer affords individuals the opportunity to make more contributions to the world, to spend more time with their loved ones, and to devote more years to their favorite activities – but a longer life, and particularly a longer retirement, is also expensive. The retirement security landscape is evolving as workers, employers, retirees, and financial services companies find their needs shifting. Once, many workers planned to stay with a single employer for most or all of their careers, building up a sizeable pension and looking forward to a comfortable retirement. Today, workers more and more workers will be employed by many different employers. Additionally, generous defined benefit (DB) retirement plans are less popular than they once were – though they were never truly commonplace – and defined contribution (DC) plans are becoming ever more prevalent.

Figure 1, below, shows the change from DB to DC that has occurred over the past three decades.

In the past many retirees struggled financially towards the end of their lives, just as they do now, but even so, the changes to the retirement security landscape have been real and marked, and have had a serious impact on workers and retirees alike. DB plans are dwindling, DC plans are on the rise, and as a result individuals must now take a more active role in managing their retirement savings. DC plans incorporate contributions from employees and employers alike, and workers much choose how to invest their nest egg. When a worker leaves a job for retirement or for a different job he or she will often roll over the money from a 401(k) plan into an Individual Retirement Account (IRA). While having more control over one’s retirement funds might seem on its face to be a net improvement, the reality is that the average American lacks the financial literacy to make sound decisions (SEC 2012).

The Council of Economic Advisers (CEA) expressed concern earlier this year that savers with IRA accounts may receive poor investment advice, particularly in cases where their financial advisors are compensated through fees and commissions. “[The] best recommendation for the saver may not be the best recommendation for the adviser’s bottom line” (CEA 2015). President Obama echoed these concerns in a speech at AARP in February, asking the Department of Labor (DoL) to update its rules for financial advisors to follow when handling IRA accounts (White House 2015). The DoL receives its authority to craft such rules and requirements from the 1974 Employee Retirement Income Security Act (ERISA) (DoL 2015a).

The DoL recently proposed a regulation designed to increase consumer protection by treating some investment advisors as fiduciaries under ERISA and the 1986 Internal Revenue Code (DoL 2015b). The proposed rule has generated heated debate, and some financial advisors have responded with great concern, arguing that it will be difficult or impossible to comply with the rule without raising costs to consumers and/or abandoning smaller accounts that generate little or no profit. Advisors who have traditionally offered only the proprietary products of a single company worry that the business model they have used for many years will no longer be considered to be serving the best interests of clients.

Rather than offering detailed comments on the DoL proposals, this paper will look more broadly at the problem of saving for retirement and the role for professional advice.This is, of course, a well-travelled road with a large literature by academics, institutions and policy-makers, however, it is worthwhile to think about market failures, lack of information and individual incentives and what they imply for the investment advice market.

Downloads

Authors

]]>
http://www.brookings.edu/blogs/up-front/posts/2015/07/29-paying-for-financial-advice-retirement-savers?rssid=economics{863C5CCF-DB3B-41B5-9727-340858CDBE76}http://webfeeds.brookings.edu/~/103948806/0/brookingsrss/programs/economics~Financial-advice-for-retirement-savers-Paying-for-advice-without-a-conflict-of-interestFinancial advice for retirement savers: Paying for advice without a conflict of interest

At one time most workplace savings took place in defined-benefit plans. Employer and worker contributions to the plan were managed by investment specialists. Upon retirement workers were guaranteed a monthly pension that lasted for the rest of their lives. The success of this kind of retirement plan did not depend on workers’ ability to manage their savings. The retirement funds of an employer’s workers were pooled and collectively managed by professionals.

Nowadays most workers in retirement plans are enrolled in a defined-contribution plan. Although an employer ordinarily contributes to the plan, the total contribution for an individual worker is usually up to the worker and is specified as a percent of the worker’s pay. Workers must decide how to allocate their contributions and when to reallocate their savings among the investment options offered in their plan. When workers leave their jobs they are only rarely given a payout as a fixed monthly payment. They must decide how fast to withdraw their savings from their retirement account and whether to rollover their accumulated savings into a new account, such as an IRA or an annuity.

In the late 1970s the great majority of private workers enrolled in retirement plans were enrolled solely in a defined-benefit plan. Nowadays an overwhelming majority of workers enrolled in retirement plans are enrolled solely in a defined-contribution plan. In the late 1970s about 70% of pension fund assets backed the promises of defined-benefit plans. In recent years only about 30% of total pension assets are held as reserves for defined-benefit plans. The huge shift in the distribution of pension claims means that individual workers are now the principal managers of their own retirement savings. Unfortunately, there is a great deal of evidence workers do not know much about investing. As a result, many depend on the investment advice they receive from advisors.

The Department of Labor (DOL) recently issued a proposed rule that would affect the kind of financial advice that workers receive when making decisions about their retirement savings. For many financial advisors the rule would change the nature of advice they can offer to retirement savers; for some it would change the way they are compensated for giving financial advice. The proposed DOL rule would change the legal standard that applies to most financial advisors. Presently, most advisors are subject to a “suitability” standard in giving advice to their clients. This requires advisors to understand their clients’ financial situation and to recommend investments that are suitable for that situation. The DOL proposes to subject advisors to a tougher “fiduciary standard.”

A fiduciary standard requires advisors to put their clients’ financial interests first. In particular, advisors would be obliged to take into account the up-front and on-going cost of alternative investment products in making investment recommendations to retirement savers. Many advisors currently have a conflict of interest in making investment recommendations. They are paid up-front or continuing fees if they persuade clients to invest in particular investment products but not in others. As noted by the Council of Economic Advisors in a report describing the effects of advisers’ conflicts of interest, there is abundant evidence that some conflicted advisors recommend investments that are remunerative to the advisor but that reduce the expected return obtained by clients. The research showing the adverse effects of conflicts of interest on advisors’ recommendations and retirement savers’ decisions is extensive and persuasive.

A counter-argument to imposing a fiduciary standard on all advisors is that the commission system, which creates adverse incentives for advisors, is necessary in order to pay for financial advice to retirement savers, especially savers who have modest accumulations. According to this argument, even conflicted advice is better than no advice at all. This claim does not seem terribly compelling. There are alternative ways to compensate financial advisors that do not create an obvious conflict between the interests of advisors and retirement savers. For example, advisors can be paid flat hourly rates or a fixed percentage of the total retirement savings for which advice is being sought. For a large percentage of the workers who have accumulated little savings, the best financial advice is often the simplest: Save as much as you can afford, and invest the bulk of your retirement savings in a low-cost target-date retirement fund that is appropriate given your age and tolerance for risk. It should not require a hefty commission to offer this advice.

Authors

At one time most workplace savings took place in defined-benefit plans. Employer and worker contributions to the plan were managed by investment specialists. Upon retirement workers were guaranteed a monthly pension that lasted for the rest of their lives. The success of this kind of retirement plan did not depend on workers’ ability to manage their savings. The retirement funds of an employer’s workers were pooled and collectively managed by professionals.

Nowadays most workers in retirement plans are enrolled in a defined-contribution plan. Although an employer ordinarily contributes to the plan, the total contribution for an individual worker is usually up to the worker and is specified as a percent of the worker’s pay. Workers must decide how to allocate their contributions and when to reallocate their savings among the investment options offered in their plan. When workers leave their jobs they are only rarely given a payout as a fixed monthly payment. They must decide how fast to withdraw their savings from their retirement account and whether to rollover their accumulated savings into a new account, such as an IRA or an annuity.

In the late 1970s the great majority of private workers enrolled in retirement plans were enrolled solely in a defined-benefit plan. Nowadays an overwhelming majority of workers enrolled in retirement plans are enrolled solely in a defined-contribution plan. In the late 1970s about 70% of pension fund assets backed the promises of defined-benefit plans. In recent years only about 30% of total pension assets are held as reserves for defined-benefit plans. The huge shift in the distribution of pension claims means that individual workers are now the principal managers of their own retirement savings. Unfortunately, there is a great deal of evidence workers do not know much about investing. As a result, many depend on the investment advice they receive from advisors.

The Department of Labor (DOL) recently issued a proposed rule that would affect the kind of financial advice that workers receive when making decisions about their retirement savings. For many financial advisors the rule would change the nature of advice they can offer to retirement savers; for some it would change the way they are compensated for giving financial advice. The proposed DOL rule would change the legal standard that applies to most financial advisors. Presently, most advisors are subject to a “suitability” standard in giving advice to their clients. This requires advisors to understand their clients’ financial situation and to recommend investments that are suitable for that situation. The DOL proposes to subject advisors to a tougher “fiduciary standard.”

A fiduciary standard requires advisors to put their clients’ financial interests first. In particular, advisors would be obliged to take into account the up-front and on-going cost of alternative investment products in making investment recommendations to retirement savers. Many advisors currently have a conflict of interest in making investment recommendations. They are paid up-front or continuing fees if they persuade clients to invest in particular investment products but not in others. As noted by the Council of Economic Advisors in a report describing the effects of advisers’ conflicts of interest, there is abundant evidence that some conflicted advisors recommend investments that are remunerative to the advisor but that reduce the expected return obtained by clients. The research showing the adverse effects of conflicts of interest on advisors’ recommendations and retirement savers’ decisions is extensive and persuasive.

A counter-argument to imposing a fiduciary standard on all advisors is that the commission system, which creates adverse incentives for advisors, is necessary in order to pay for financial advice to retirement savers, especially savers who have modest accumulations. According to this argument, even conflicted advice is better than no advice at all. This claim does not seem terribly compelling. There are alternative ways to compensate financial advisors that do not create an obvious conflict between the interests of advisors and retirement savers. For example, advisors can be paid flat hourly rates or a fixed percentage of the total retirement savings for which advice is being sought. For a large percentage of the workers who have accumulated little savings, the best financial advice is often the simplest: Save as much as you can afford, and invest the bulk of your retirement savings in a low-cost target-date retirement fund that is appropriate given your age and tolerance for risk. It should not require a hefty commission to offer this advice.

Financial advisors offers their clients many advantages, such as setting reasonable savings goals, avoiding fraudulent investments and mistakes like buying high and selling low, and determining the right level of risk for a particular household. However, these same advisors are often incentivized to choose funds that increase their own financial rewards, and the nature and amount of the fees received by advisors may not be transparent to their clients, and small-scale savers may not be able to access affordable advice at all. What is in the best interest of an individual may not be in the best interest of his or her financial advisor.

To combat this problem, the Department of Labor (DoL) recently proposed a regulation designed to increase consumer protection by treating some investment advisors as fiduciaries under ERISA and the 1986 Internal Revenue Code. The proposed conflict of interest rule is an important step in the right direction to increasing consumer protections. It addresses evidence from a February 2015 report by the Council of Economic Advisers suggesting that consumers often receive poor recommendations from their financial advisors and that as a result their investment returns on IRAs are about 1 percentage point lower each year. Naturally, the proposal is not without its controversies and it has already attracted at least 775 public comments, including one from us .

For us, the DoL’s proposed rule is a significant step in the right direction towards increased consumer protection and retirement security. It is important to make sure that retirement advisors face the right incentives and place customer interests first. It is also important make sure savers can access good advice so they can make sound decisions and avoid costly mistakes. However, some thoughtful revisions are needed to ensure the rule offers a net benefit.

If the rule causes advisors’ compliance costs to rise, they may abandon clients with small-scale savings, since these clients will no longer be profitable for them. If these small-scale savers are crowded out of the financial advice market, we might see the retirement savings gap widen. Therefore we encourage the DoL to consider ways to minimize or manage these costs, perhaps by incentivizing advisors to continue guiding these types of clients. We also worry that the proposed rule does not adequately clarify the difference between education and advice, and encourage the DoL to close any potential loopholes by standardizing the general educational information that advisors can share without triggering fiduciary responsibility (which DoL is trying to do). Finally, the proposed rule could encourage some advisors to become excessively risk averse in an overzealous attempt to avoid litigation or other negative consequences. Extreme risk aversion could decrease market returns for investors and the ‘value-add’ of professional advisors, so we suggest the DoL think carefully about discouraging conflicted advice without also discouraging healthy risk.

The proposed rule addresses an important problem, but in its current form it may open the door to some undesirable or problematic outcomes. We explore these issues in further details in our recent paper.

Authors

Financial advisors offers their clients many advantages, such as setting reasonable savings goals, avoiding fraudulent investments and mistakes like buying high and selling low, and determining the right level of risk for a particular household. However, these same advisors are often incentivized to choose funds that increase their own financial rewards, and the nature and amount of the fees received by advisors may not be transparent to their clients, and small-scale savers may not be able to access affordable advice at all. What is in the best interest of an individual may not be in the best interest of his or her financial advisor.

To combat this problem, the Department of Labor (DoL) recently proposed a regulation designed to increase consumer protection by treating some investment advisors as fiduciaries under ERISA and the 1986 Internal Revenue Code. The proposed conflict of interest rule is an important step in the right direction to increasing consumer protections. It addresses evidence from a February 2015 report by the Council of Economic Advisers suggesting that consumers often receive poor recommendations from their financial advisors and that as a result their investment returns on IRAs are about 1 percentage point lower each year. Naturally, the proposal is not without its controversies and it has already attracted at least 775 public comments, including one from us .

For us, the DoL’s proposed rule is a significant step in the right direction towards increased consumer protection and retirement security. It is important to make sure that retirement advisors face the right incentives and place customer interests first. It is also important make sure savers can access good advice so they can make sound decisions and avoid costly mistakes. However, some thoughtful revisions are needed to ensure the rule offers a net benefit.

If the rule causes advisors’ compliance costs to rise, they may abandon clients with small-scale savings, since these clients will no longer be profitable for them. If these small-scale savers are crowded out of the financial advice market, we might see the retirement savings gap widen. Therefore we encourage the DoL to consider ways to minimize or manage these costs, perhaps by incentivizing advisors to continue guiding these types of clients. We also worry that the proposed rule does not adequately clarify the difference between education and advice, and encourage the DoL to close any potential loopholes by standardizing the general educational information that advisors can share without triggering fiduciary responsibility (which DoL is trying to do). Finally, the proposed rule could encourage some advisors to become excessively risk averse in an overzealous attempt to avoid litigation or other negative consequences. Extreme risk aversion could decrease market returns for investors and the ‘value-add’ of professional advisors, so we suggest the DoL think carefully about discouraging conflicted advice without also discouraging healthy risk.

The proposed rule addresses an important problem, but in its current form it may open the door to some undesirable or problematic outcomes. We explore these issues in further details in our recent paper.

Authors

]]>
http://www.brookings.edu/blogs/up-front/posts/2015/07/29-research-fiduciary-rule-comes-from?rssid=economics{1A6A68C7-80D5-4836-B838-7D2F524EF509}http://webfeeds.brookings.edu/~/103977016/0/brookingsrss/programs/economics~Caveat-emptor-Watch-where-research-on-the-fiduciary-rule-comes-fromCaveat emptor: Watch where research on the fiduciary rule comes from

There’s nothing warm and fuzzy about retirement. If we’re lucky, it’s the thing we do before we die. It’s expensive. We might have to do it alone. On top of our own problems, it’s unpleasant to think about how our parents might run out of money in their retirement and then depend on us for financial support and care-giving. Your parents might need advice, and so might you.

You want that advice to be in your best interest but, too often, it isn’t. Many advisors are paid to recommend investments that generate income for them even when better options are available for you. As a result, you might lose a lot of money or not see your investments grow as quickly. Right now, the Obama administration is proposing to update regulations so that such practices will cease. But special interest groups that benefit from the status quo are spending a lot of money to stop the rule from taking effect.

Specifically, the Department of Labor has proposed a regulation to curb “conflicts of interest.” This rule would require an advisor helping you with your retirement investments to be held to a fiduciary, or “best interest,” standard. If this rule takes effect, it would amend existing regulations that currently permit experts advising on retirement investments to be paid more by recommending certain investments over others, even when such advice is not in the best interest of their clients. Today, there’s little to stop ‘advisors’ from getting paid extra to put you or your parents into inferior investments, a practice one finance professor called “superslimy.”

To no surprise, those benefiting from current practices have paid for research to try to discredit the proposed rule. Such research claims that people don’t lose as much money from biased advice as careful, independentresearch has shown. Research not funded by special interest groups concludes that when they are paid to recommend certain financial products over others, advisors tilt their recommendations so that they receive higher pay. In other words, advisors respond to financial incentives just like the rest of us. Such biased advice hurts savers by lowering returns and by increasing fees.

Independent research must generally undergo an anonymous review process before publication. Studies funded by special interests need not face such scrutiny. When it is to their advantage, they may use analytic techniques that would not be accepted in academic research, draw inaccurate inferences, use inappropriate data, or selectively report the results.

In addition to denying the harm of biased advice, critics of the regulation pivot and allege that the Department of Labor has not crafted the right solution to a problem whose existence they initially denied. Although there are many serious ways to assess the merits of the proposal, some special interest groups assert that the proposed solution will curtail advice to savers, leaving them worse off. But, simply put, unbiased and unconflicted advice is now available at a low cost from people and from sophisticated computer software. It is even available for low-balance savers. It would be a major step forward if advisors working on behalf of their clients did not have to compete with people who purport to act for their clients but who, in fact, are being paid by third parties. The public discussion should thus focus on how best to curb practices that harm people and how best to assure that retirement savers receive advice that is in their best interest.

Authors

There’s nothing warm and fuzzy about retirement. If we’re lucky, it’s the thing we do before we die. It’s expensive. We might have to do it alone. On top of our own problems, it’s unpleasant to think about how our parents might run out of money in their retirement and then depend on us for financial support and care-giving. Your parents might need advice, and so might you.

You want that advice to be in your best interest but, too often, it isn’t. Many advisors are paid to recommend investments that generate income for them even when better options are available for you. As a result, you might lose a lot of money or not see your investments grow as quickly. Right now, the Obama administration is proposing to update regulations so that such practices will cease. But special interest groups that benefit from the status quo are spending a lot of money to stop the rule from taking effect.

Specifically, the Department of Labor has proposed a regulation to curb “conflicts of interest.” This rule would require an advisor helping you with your retirement investments to be held to a fiduciary, or “best interest,” standard. If this rule takes effect, it would amend existing regulations that currently permit experts advising on retirement investments to be paid more by recommending certain investments over others, even when such advice is not in the best interest of their clients. Today, there’s little to stop ‘advisors’ from getting paid extra to put you or your parents into inferior investments, a practice one finance professor called “superslimy.”

To no surprise, those benefiting from current practices have paid for research to try to discredit the proposed rule. Such research claims that people don’t lose as much money from biased advice as careful, independentresearch has shown. Research not funded by special interest groups concludes that when they are paid to recommend certain financial products over others, advisors tilt their recommendations so that they receive higher pay. In other words, advisors respond to financial incentives just like the rest of us. Such biased advice hurts savers by lowering returns and by increasing fees.

Independent research must generally undergo an anonymous review process before publication. Studies funded by special interests need not face such scrutiny. When it is to their advantage, they may use analytic techniques that would not be accepted in academic research, draw inaccurate inferences, use inappropriate data, or selectively report the results.

In addition to denying the harm of biased advice, critics of the regulation pivot and allege that the Department of Labor has not crafted the right solution to a problem whose existence they initially denied. Although there are many serious ways to assess the merits of the proposal, some special interest groups assert that the proposed solution will curtail advice to savers, leaving them worse off. But, simply put, unbiased and unconflicted advice is now available at a low cost from people and from sophisticated computer software. It is even available for low-balance savers. It would be a major step forward if advisors working on behalf of their clients did not have to compete with people who purport to act for their clients but who, in fact, are being paid by third parties. The public discussion should thus focus on how best to curb practices that harm people and how best to assure that retirement savers receive advice that is in their best interest.

Authors

]]>
http://www.brookings.edu/research/opinions/2015/07/28-state-income-tax-cuts-bad-idea-gale?rssid=economics{8406E8E7-DDE0-4142-8500-AE3DC4C4775A}http://webfeeds.brookings.edu/~/103705850/0/brookingsrss/programs/economics~State-income-tax-cuts-Still-a-bad-ideaState income tax cuts: Still a bad idea

Ever since the 1970s, when Jude Wanniski and Arthur Laffer came up with the ideas that are now referred to as supply-side economics, conservative politicians have been unable to resist the siren song of tax cuts for big earners. In recent years, this enthusiasm has spread to state governments led by conservatives, offering new tests of a proposition that has generated scant evidence of success elsewhere.

In the extreme versions that thrived through the early Reagan Administration years, supply-siders argued tax cuts would pay for themselves by increasing growth substantially. After decades in which lower tax rates generated less revenue rather than more, today’s supply-siders usually make more the modest claim that tax cuts will spur growth that makes up for part of the revenue losses. However, some proponents still can’t help themselves and lapse into the more hyperbolic claims.

But the record is clear that tax cuts have not boosted growth. When growth is (appropriately) measured from peak to peak of the business cycle, the vaunted Reagan tax cuts in the early 1980s produced a period of average growth. Indeed, research by Martin Feldstein, President Reagan’s former chief economist, and Doug Elmendorf, the former Congressional Budget Office Director, concluded that the 1981 tax cuts had virtually no net impact on growth.

Virtually no one claims the 2001 and 2003 Bush tax cuts stimulated growth. Despite cuts in tax rates on ordinary income, capital gains, dividends, and estates, economic growth remained sluggish between 2001 and the beginning of the Great Recession in late-2007. The growth that did occur, however, is generally attributed to the Fed’s easy money policy.

Tax rates as determinants of growth fare no better in cross-country comparisons. Research by Thomas Piketty (Paris School of Economics), Emmanuel Saez (UC-Berkeley), and Stefanie Stantcheva (MIT) found no relationship between how a country changed its top marginal tax rate and how rapidly it grew between 1960 and 2010. For example, the United States cut its top rate by over 40 percentage points and grew just over 2 percent annually per capita. Germany and Denmark, which barely changed their top rates at all, experienced about the same growth rate.

The story is much the same when total tax burdens are compared. Over the 1970-2012 period, taxes as a share of GDP were 7 percentage points higher in the rest of the OECD countries (32 percent) than in the United States (25 percent). Yet, per capita annual growth was virtually identical in the rest of the OECD (1.80 percent) compared to the United States alone.

So, there is no reason to believe that tax cuts are an elixir for economic growth. There’s another problem here as well. As Piketty and company note, with or without the elusive supply-side effect, high-end tax cuts have exacerbated income inequality.

Despite all of this, the zeal for lowering income tax rates, especially at the top, spread beyond Washington decades ago. Failure at the federal level does not necessarily imply that tax cuts would fail at the state level too. Lower taxes might lure businesses from other states, even if they yield no collective increase in jobs or output. But the stakes are higher for the states, which can’t borrow the way the Federal government can. As a result, they often end up enacting regressive tax increases or regressive spending cuts when high-income tax cuts fail to produce the promised growth.

In the 1990s, six states cut taxes by more than ten percent, mostly by enacting significant personal income tax cuts. However, only the tax-cut states that were boosted by the financial boom rose faster than average. Between 2001 and 2007, Arizona, Louisiana, New Mexico, Ohio, Oklahoma, and Rhode Island cut personal income taxes. Only New Mexico and Oklahoma, which benefited from oil and gas trends, experienced net gains in their employment share over an extended period.

The most widely-reported recent state income tax cut occurred in Kansas in 2012. Gov. Sam Brownback argued it would be “like a shot of adrenaline into the heart of the Kansas economy.” The tax cuts did not produce the hoped-for growth, though, and more revenue was lost than originally anticipated. Fiscal year 2014 revenues were $700 million lower than FY 2013 -- $330 million less than expected – during a period in which most of the American economy was picking up steam. Put in context, these numbers are pretty significant: $330 million represents more than 5 percent of Kansas’ government spending from general funds. Moody’s and Standard and Poor’s reduced Kansas’ credit rating, and the state failed to keep up with the region’s pace of job growth.

Rather than reversing the income tax cuts, though, the Kansas legislature in June raised regressive taxes on sales and cigarettes. Louisiana, Wisconsin, and other states have similarly financed tax cuts for high-income households with regressive policies, including cuts in social spending or increases in regressive taxes.

At the core of supply-side economics is Art Laffer’s back-of-the napkin curve illustrating the obvious reality that, at some point, higher tax rates will lead to lower revenues as well as fewer jobs and slower growth. But this does not imply there are many real-world examples of tax rates so high that cutting them would have much impact on jobs or growth. That concept has been amply demonstrated at the national level, where tax cuts have eroded revenue without discernable effect on economic activity.

The states have no good reasons to believe that tax cuts will bring the desired manna. Yet they continue to erode their tax bases in the name of business growth during an era in which few states can afford to cut critical services ranging from education to infrastructure repair. Some ideas live on and on, no matter how much evidence accumulates against them. States that follow them do so at their own peril.

Authors

Ever since the 1970s, when Jude Wanniski and Arthur Laffer came up with the ideas that are now referred to as supply-side economics, conservative politicians have been unable to resist the siren song of tax cuts for big earners. In recent years, this enthusiasm has spread to state governments led by conservatives, offering new tests of a proposition that has generated scant evidence of success elsewhere.

In the extreme versions that thrived through the early Reagan Administration years, supply-siders argued tax cuts would pay for themselves by increasing growth substantially. After decades in which lower tax rates generated less revenue rather than more, today’s supply-siders usually make more the modest claim that tax cuts will spur growth that makes up for part of the revenue losses. However, some proponents still can’t help themselves and lapse into the more hyperbolic claims.

But the record is clear that tax cuts have not boosted growth. When growth is (appropriately) measured from peak to peak of the business cycle, the vaunted Reagan tax cuts in the early 1980s produced a period of average growth. Indeed, research by Martin Feldstein, President Reagan’s former chief economist, and Doug Elmendorf, the former Congressional Budget Office Director, concluded that the 1981 tax cuts had virtually no net impact on growth.

Virtually no one claims the 2001 and 2003 Bush tax cuts stimulated growth. Despite cuts in tax rates on ordinary income, capital gains, dividends, and estates, economic growth remained sluggish between 2001 and the beginning of the Great Recession in late-2007. The growth that did occur, however, is generally attributed to the Fed’s easy money policy.

Tax rates as determinants of growth fare no better in cross-country comparisons. Research by Thomas Piketty (Paris School of Economics), Emmanuel Saez (UC-Berkeley), and Stefanie Stantcheva (MIT) found no relationship between how a country changed its top marginal tax rate and how rapidly it grew between 1960 and 2010. For example, the United States cut its top rate by over 40 percentage points and grew just over 2 percent annually per capita. Germany and Denmark, which barely changed their top rates at all, experienced about the same growth rate.

The story is much the same when total tax burdens are compared. Over the 1970-2012 period, taxes as a share of GDP were 7 percentage points higher in the rest of the OECD countries (32 percent) than in the United States (25 percent). Yet, per capita annual growth was virtually identical in the rest of the OECD (1.80 percent) compared to the United States alone.

So, there is no reason to believe that tax cuts are an elixir for economic growth. There’s another problem here as well. As Piketty and company note, with or without the elusive supply-side effect, high-end tax cuts have exacerbated income inequality.

Despite all of this, the zeal for lowering income tax rates, especially at the top, spread beyond Washington decades ago. Failure at the federal level does not necessarily imply that tax cuts would fail at the state level too. Lower taxes might lure businesses from other states, even if they yield no collective increase in jobs or output. But the stakes are higher for the states, which can’t borrow the way the Federal government can. As a result, they often end up enacting regressive tax increases or regressive spending cuts when high-income tax cuts fail to produce the promised growth.

In the 1990s, six states cut taxes by more than ten percent, mostly by enacting significant personal income tax cuts. However, only the tax-cut states that were boosted by the financial boom rose faster than average. Between 2001 and 2007, Arizona, Louisiana, New Mexico, Ohio, Oklahoma, and Rhode Island cut personal income taxes. Only New Mexico and Oklahoma, which benefited from oil and gas trends, experienced net gains in their employment share over an extended period.

The most widely-reported recent state income tax cut occurred in Kansas in 2012. Gov. Sam Brownback argued it would be “like a shot of adrenaline into the heart of the Kansas economy.” The tax cuts did not produce the hoped-for growth, though, and more revenue was lost than originally anticipated. Fiscal year 2014 revenues were $700 million lower than FY 2013 -- $330 million less than expected – during a period in which most of the American economy was picking up steam. Put in context, these numbers are pretty significant: $330 million represents more than 5 percent of Kansas’ government spending from general funds. Moody’s and Standard and Poor’s reduced Kansas’ credit rating, and the state failed to keep up with the region’s pace of job growth.

Rather than reversing the income tax cuts, though, the Kansas legislature in June raised regressive taxes on sales and cigarettes. Louisiana, Wisconsin, and other states have similarly financed tax cuts for high-income households with regressive policies, including cuts in social spending or increases in regressive taxes.

At the core of supply-side economics is Art Laffer’s back-of-the napkin curve illustrating the obvious reality that, at some point, higher tax rates will lead to lower revenues as well as fewer jobs and slower growth. But this does not imply there are many real-world examples of tax rates so high that cutting them would have much impact on jobs or growth. That concept has been amply demonstrated at the national level, where tax cuts have eroded revenue without discernable effect on economic activity.

The states have no good reasons to believe that tax cuts will bring the desired manna. Yet they continue to erode their tax bases in the name of business growth during an era in which few states can afford to cut critical services ranging from education to infrastructure repair. Some ideas live on and on, no matter how much evidence accumulates against them. States that follow them do so at their own peril.

Authors

]]>
http://www.brookings.edu/events/2015/07/28-clinical-pharmacology-and-experimental-medicine?rssid=economics{725712CB-E184-4AA9-9BA3-584B00673919}http://webfeeds.brookings.edu/~/103663044/0/brookingsrss/programs/economics~Improving-productivity-in-pharmaceutical-research-and-developmentImproving productivity in pharmaceutical research and development

Event Information

The high failure rate of investigational compounds during drug development, especially in late stages of the clinical development process, is widely seen as a key contributor to the outsize amount of time and resources necessary to develop new drugs. Advances in clinical pharmacology and experimental medicine have the potential to rebalance these trends by providing researchers with the tools to more efficiently and systematically identify promising targets and compounds, appropriate patient populations, and adequate doses for study much earlier in development.

On July 28, the Center for Health Policy at Brookings, in collaboration with the International Consortium for Innovation & Quality in Pharmaceutical Development and the U.S. Food and Drug Administration (FDA), hosted a public meeting to tackle these issues. Through presentations and case studies, leading experts from industry, academia, and government agencies explored the evolving role of clinical pharmacology tools in pre-clinical and clinical development, existing gaps in the application of those tools, and how emerging science could be better leveraged to improve the efficiency of drug development programs and better optimize treatments. Discussion at this event will potentially be harnessed to inform downstream guidance documents, to establish best practices for the application of emerging clinical pharmacology tools, or to support academic publications. Speakers will convene privately to discuss such downstream deliverables and key takeaways from the conference.

The high failure rate of investigational compounds during drug development, especially in late stages of the clinical development process, is widely seen as a key contributor to the outsize amount of time and resources necessary to develop new drugs. Advances in clinical pharmacology and experimental medicine have the potential to rebalance these trends by providing researchers with the tools to more efficiently and systematically identify promising targets and compounds, appropriate patient populations, and adequate doses for study much earlier in development.

On July 28, the Center for Health Policy at Brookings, in collaboration with the International Consortium for Innovation & Quality in Pharmaceutical Development and the U.S. Food and Drug Administration (FDA), hosted a public meeting to tackle these issues. Through presentations and case studies, leading experts from industry, academia, and government agencies explored the evolving role of clinical pharmacology tools in pre-clinical and clinical development, existing gaps in the application of those tools, and how emerging science could be better leveraged to improve the efficiency of drug development programs and better optimize treatments. Discussion at this event will potentially be harnessed to inform downstream guidance documents, to establish best practices for the application of emerging clinical pharmacology tools, or to support academic publications. Speakers will convene privately to discuss such downstream deliverables and key takeaways from the conference.

The sustainability of the U.S. fiscal outlook depends on the path of health costs, particularly Medicare, the health insurance program for the elderly and disabled. If health costs continue to rise more rapidly than gross domestic product, then Medicare will be increasingly unaffordable. The recent slowdown in Medicare spending has been touted as evidence that the health cost curve has finally "bent" and that the Medicare financing problem can be managed with modest changes in policy.

The Medicare Trustees report, released last week, basically confirms this view. Under the trustees' baseline projection, Medicare spending increases from 3.5% of GDP today to 5.5% by 2050 and 6% by 2080. In contrast, the Congressional Budget Office, in June, projected much larger increases in Medicare spending over time, with spending reaching 7% of GDP by 2050 and over 11% by 2080.

How can projections by the government's best experts be so different? And which should we believe?

Both the trustees and the CBO assume that the growth both of public and private health spending will slow over time, as the incremental benefit from additional health care becomes less valuable. Where they differ is in what is assumed about Medicare spending growth relative to growth other health spending.

The trustees assume that per capita Medicare spending will rise more slowly than other health spending; CBO assumes that Medicare spending will rise more rapidly.

The trustees look at the provisions of the Affordable Care Act governing provider reimbursements and conclude that Medicare payments under the Affordable Care Act are increasingly likely to fall below reimbursement by private insurers and Medicaid (the state-federal program for the poor) over time. Thus, they expect Medicare spending to rise more slowly than other health spending.

CBO economists believe future health spending is too uncertain to be modeled. They consider the effects of legislation only over the ten-year budget window—that is, from fiscal years 2015 to 2024.

After that, they use a mechanical rule to project Medicare spending per beneficiary. But this mechanical rule assumes that, under current law, Medicare will have less flexibility than private insurers and Medicaid to take measures to slow health spending growth. Thus, CBO assumes that per beneficiary Medicare spending increases faster than other health spending.

Which of these should be believed? Neither. Health spending is almost impossible to predict. Assuming that past trends continue indefinitely produces nonsensical results, as it implies that health spending will eventually consume all of GDP. But forecasting how the future will be different from the past is not something we know how to do. The large wedge between these two arguably sensible projections of Medicare should be taken as evidence that we really don't know how big a fiscal problem health spending will be 25 or 50 years in the future.

Authors

The sustainability of the U.S. fiscal outlook depends on the path of health costs, particularly Medicare, the health insurance program for the elderly and disabled. If health costs continue to rise more rapidly than gross domestic product, then Medicare will be increasingly unaffordable. The recent slowdown in Medicare spending has been touted as evidence that the health cost curve has finally "bent" and that the Medicare financing problem can be managed with modest changes in policy.

The Medicare Trustees report, released last week, basically confirms this view. Under the trustees' baseline projection, Medicare spending increases from 3.5% of GDP today to 5.5% by 2050 and 6% by 2080. In contrast, the Congressional Budget Office, in June, projected much larger increases in Medicare spending over time, with spending reaching 7% of GDP by 2050 and over 11% by 2080.

How can projections by the government's best experts be so different? And which should we believe?

Both the trustees and the CBO assume that the growth both of public and private health spending will slow over time, as the incremental benefit from additional health care becomes less valuable. Where they differ is in what is assumed about Medicare spending growth relative to growth other health spending.

The trustees assume that per capita Medicare spending will rise more slowly than other health spending; CBO assumes that Medicare spending will rise more rapidly.

The trustees look at the provisions of the Affordable Care Act governing provider reimbursements and conclude that Medicare payments under the Affordable Care Act are increasingly likely to fall below reimbursement by private insurers and Medicaid (the state-federal program for the poor) over time. Thus, they expect Medicare spending to rise more slowly than other health spending.

CBO economists believe future health spending is too uncertain to be modeled. They consider the effects of legislation only over the ten-year budget window—that is, from fiscal years 2015 to 2024.

After that, they use a mechanical rule to project Medicare spending per beneficiary. But this mechanical rule assumes that, under current law, Medicare will have less flexibility than private insurers and Medicaid to take measures to slow health spending growth. Thus, CBO assumes that per beneficiary Medicare spending increases faster than other health spending.

Which of these should be believed? Neither. Health spending is almost impossible to predict. Assuming that past trends continue indefinitely produces nonsensical results, as it implies that health spending will eventually consume all of GDP. But forecasting how the future will be different from the past is not something we know how to do. The large wedge between these two arguably sensible projections of Medicare should be taken as evidence that we really don't know how big a fiscal problem health spending will be 25 or 50 years in the future.

The congressional budget process is broken and needs drastic reconstruction. In nearly half of the past two decades, a staggering nine years, Congress failed to pass a budget agreement — the essential step in following its own rules for budget decision-making. Instead, the federal government lurched from one budget crisis to another with bizarre ad hoc procedures — government shutdowns, sequestration, the fiscal cliff and a supercommittee — and funded the government through continuing resolutions and massive omnibus appropriations bills.

The disarray of the budget process, of course, is a symptom of the gridlock- producing polarization of our politics and the breakdown of respect for the normal processes of communication which enable opposing sides to compromise their differences and keep the government functioning. But even without the stresses of unusually polarized political positions, the budget process needed drastic repair. It was too cumbersome and complex, failed to include the most rapidly growing parts of the budget — entitlement spending and expenditures through the tax code — and was almost impossible for the public, or even participants to understand. This inability to deliver on basic fiscal responsibility occurred under Republican and Democratic presidents and in Congresses controlled by one party, as well as ones with split majorities. We desperately need a new process that can produce a timely budget that allows the government to function with less uncertainty and more efficiency.

The two of us are from different political parties and have held leadership roles in the federal budget process, and we consulted widely with others to produce 10 recommendations. We advocate a budget process that includes all federal spending and revenues, including entitlements and tax expenditures; that is transparent and timely; and that entails a buy-in from the president and congressional leadership. Some will consider our proposals too drastic and others will find them too incremental, but we hope they will spark debate and action.

We propose changing the current annual budgeting cycle to biennial in which Congress would adopt a budget and appropriation bills in the first session, leaving time in the second session for oversight and the moribund authorization process to work. A biennial budget has wide bipartisan support. Congressman Leon Panetta authored the first biennial reform bill that was introduced in 1977 and the idea has been supported by the administrations of presidents Ronald Reagan, George Bush, Bill Clinton and George W. Bush.

As an incentive, if there is failure to adopt a budget plan by April 15 of the first session, we recommend that all planned congressional recesses be canceled until an agreement is at hand. This may sound like a gimmick, but it would only apply to the public sector the norms of the private sector, where nonperformance results in nonpayment. The American taxpayer has the right to demand elected officials remain on their jobs until duties are completed.

We propose that upon the adoption of a budget blueprint, the statutory debt ceiling be automatically adjusted to be consistent with the budget numbers. We also recommend that failure to adopt a biennial appropriation bill would result in automatic funding of government programs and agencies at the previous year’s level. This proposal unfortunately is necessary because only two times in the past 40 years have all individual appropriation bills been completed on time, the last being in 1994. It would avoid the threat of government shutdowns.

We also recommend establishing a high-level presidential and congressional commission on budget concepts and procedures. The commission would focus on the congressional budget process and the roles of the executive branch, independent regulatory agencies, the judicial branch and the Federal Reserve on impacting fiscal policy.

We know reforming the process will not eliminate partisan polarization, establish collegiality or restore civil discourse. But it can help.

Fixing the budget process requires the will of lawmakers and the president. This Congress in its early days and this president in his waning days have shown that they can come together and pass legislation that started with deep divisions but eventually ended with agreement. So why not use that momentum to fix this long-standing problem.

Difficult political decisions demand more than new budget tools. They require political will. It is time for Congress to show it has the tools and the will to do its job.

Authors

The congressional budget process is broken and needs drastic reconstruction. In nearly half of the past two decades, a staggering nine years, Congress failed to pass a budget agreement — the essential step in following its own rules for budget decision-making. Instead, the federal government lurched from one budget crisis to another with bizarre ad hoc procedures — government shutdowns, sequestration, the fiscal cliff and a supercommittee — and funded the government through continuing resolutions and massive omnibus appropriations bills.

The disarray of the budget process, of course, is a symptom of the gridlock- producing polarization of our politics and the breakdown of respect for the normal processes of communication which enable opposing sides to compromise their differences and keep the government functioning. But even without the stresses of unusually polarized political positions, the budget process needed drastic repair. It was too cumbersome and complex, failed to include the most rapidly growing parts of the budget — entitlement spending and expenditures through the tax code — and was almost impossible for the public, or even participants to understand. This inability to deliver on basic fiscal responsibility occurred under Republican and Democratic presidents and in Congresses controlled by one party, as well as ones with split majorities. We desperately need a new process that can produce a timely budget that allows the government to function with less uncertainty and more efficiency.

The two of us are from different political parties and have held leadership roles in the federal budget process, and we consulted widely with others to produce 10 recommendations. We advocate a budget process that includes all federal spending and revenues, including entitlements and tax expenditures; that is transparent and timely; and that entails a buy-in from the president and congressional leadership. Some will consider our proposals too drastic and others will find them too incremental, but we hope they will spark debate and action.

We propose changing the current annual budgeting cycle to biennial in which Congress would adopt a budget and appropriation bills in the first session, leaving time in the second session for oversight and the moribund authorization process to work. A biennial budget has wide bipartisan support. Congressman Leon Panetta authored the first biennial reform bill that was introduced in 1977 and the idea has been supported by the administrations of presidents Ronald Reagan, George Bush, Bill Clinton and George W. Bush.

As an incentive, if there is failure to adopt a budget plan by April 15 of the first session, we recommend that all planned congressional recesses be canceled until an agreement is at hand. This may sound like a gimmick, but it would only apply to the public sector the norms of the private sector, where nonperformance results in nonpayment. The American taxpayer has the right to demand elected officials remain on their jobs until duties are completed.

We propose that upon the adoption of a budget blueprint, the statutory debt ceiling be automatically adjusted to be consistent with the budget numbers. We also recommend that failure to adopt a biennial appropriation bill would result in automatic funding of government programs and agencies at the previous year’s level. This proposal unfortunately is necessary because only two times in the past 40 years have all individual appropriation bills been completed on time, the last being in 1994. It would avoid the threat of government shutdowns.

We also recommend establishing a high-level presidential and congressional commission on budget concepts and procedures. The commission would focus on the congressional budget process and the roles of the executive branch, independent regulatory agencies, the judicial branch and the Federal Reserve on impacting fiscal policy.

We know reforming the process will not eliminate partisan polarization, establish collegiality or restore civil discourse. But it can help.

Fixing the budget process requires the will of lawmakers and the president. This Congress in its early days and this president in his waning days have shown that they can come together and pass legislation that started with deep divisions but eventually ended with agreement. So why not use that momentum to fix this long-standing problem.

Difficult political decisions demand more than new budget tools. They require political will. It is time for Congress to show it has the tools and the will to do its job.

As more Americans pursue college degrees, it has become less of an obstacle to becoming a leader in the military, hurting their relative quality.

The law of unintended consequences is alive and well in a strange place: more Americans are going to college, which is a good thing, but it has reduced the quality of officers joining the military.

I saw the importance of having a high-quality officer corps firsthand when I was deployed with an infantry company to Sangin, Afghanistan in 2011. For seven frustrating months, our battalion was stuck in a Groundhog’s Day of either finding improvised explosive devices (IEDs) or having the IEDs find us. The only variation was imposed on us by the actions of the other side.

Waiting for the plane home, I joked to another officer, “That was nothing like what the counterinsurgency manual described.”

“I wouldn’t know – I haven’t read it,” he replied. “I don’t need a book to tell me what to do.”

This anecdote of one lieutenant’s antipathy to “book learning” reflects a deeper problem: the decline in the intelligence of military officers, which our recent study found has become significant. This is not just a result of continuing wars in Iraq and Afghanistan, but has been a trend for at least 35 years.

Using data from a Freedom of Information Act request, we found that the average intelligence of Marine Corps officers has dropped since 1980. For example, 41% of new Marine officers in 2014 would not have met the intelligence standards demanded of officers in World War II. This decline is especially surprising because, as others have documented, 2011 saw the most intelligent group of enlistees in the history of the volunteer military. Thus, even as the intelligence of our enlisted troops have been rising, that of our commissioned officers has been declining.

Why the decrease in officer quality?

We didn’t find it was due to more minorities or women in the ranks, as many have assumed. The basic answer is that more people are going to college. Officers in the volunteer military have always been required to have a four-year college degree. The pool of college students has increased by over 50% since 1980, so these days a lot more Americans meet the key qualification to become an officer than was the case three decades ago. That has been very positive for society by increasing social mobility. But perhaps it hasn’t been all good news. The expansion of the pool of college students means a larger, but lower quality, pool of potential officers. While our data were about Marine officers, the results likely apply to the whole military.

Another example drawn from my experience shows the problems created by a lack of intellectual curiosity. The Afghan Army had several large pictures in their bases and on their trucks of Ahmed Shah Massoud, the famous Tajik warlord who fought against the Soviets. Few of the Marine officers knew his history, but more importantly many others didn’t care to learn. They then couldn’t understand why the local Pashtuns were upset with the presence of “foreign” Tajik troops in their village. Wrongly, we measured success as merely counting the number of Afghan Army patrols, which we took as an indicator of closer relations with the local Pashtuns, without recognizing how the locals truly felt.

Our military is being given increasingly complex and diverse missions across the globe; it doesn’t make sense to train a young officer how to fight against the Soviets in World War III and then ask him or her to be a sociologist and diplomat. But as long as the United States relies on the military to conduct foreign affairs, the military needs to be staffed with knowledgeable, intellectually capable officers.

This decline has not been helped by the anti-military culture that has prevailed at elite universities since the Vietnam War. While Harvard University restored its ROTC program following the repeal of ‘Don’t Ask, Don’t Tell’ in 2011, the continued paucity of cadets there belies their claim that it was always about homosexuals in the military. This year, only *one* cadet was commissioned from Harvard into the Navy — hardly the contribution we would need to create a more intelligent officer corps.

This need for critical thinkers was recognized well before the current wars. In the 1990s, Marine General Charles Krulak wrote of the “Three Block War.” In a single city, the military is conducting humanitarian relief on one block; peacekeeping operations are conducted on the next; and in the third, the troops are engaged in a full-out fight for their lives. Krulak’s prediction was eerily prescient; in Iraq and Afghanistan, we would hand out candy to children on one block, on the next we were trying to solve problems of local governance, and on the third we were walking through a minefield of IEDs.

The military needs intelligent, flexible leaders. We are lacking enough of them right now. As a first step, administer the existing enlisted intelligence test (ASVAB) to all potential officers’ intelligence. After a year of results, establish a minimum score as a short-term solution. In the long-term, we will need to critically evaluate what qualifications produce a successful officer and how we measure those qualifications. The long-term solution will be complicated, but it is vital. Not just for national security, but for the sake of the enlistees who entrust their lives to officers.

Authors

As more Americans pursue college degrees, it has become less of an obstacle to becoming a leader in the military, hurting their relative quality.

The law of unintended consequences is alive and well in a strange place: more Americans are going to college, which is a good thing, but it has reduced the quality of officers joining the military.

I saw the importance of having a high-quality officer corps firsthand when I was deployed with an infantry company to Sangin, Afghanistan in 2011. For seven frustrating months, our battalion was stuck in a Groundhog’s Day of either finding improvised explosive devices (IEDs) or having the IEDs find us. The only variation was imposed on us by the actions of the other side.

Waiting for the plane home, I joked to another officer, “That was nothing like what the counterinsurgency manual described.”

“I wouldn’t know – I haven’t read it,” he replied. “I don’t need a book to tell me what to do.”

This anecdote of one lieutenant’s antipathy to “book learning” reflects a deeper problem: the decline in the intelligence of military officers, which our recent study found has become significant. This is not just a result of continuing wars in Iraq and Afghanistan, but has been a trend for at least 35 years.

Using data from a Freedom of Information Act request, we found that the average intelligence of Marine Corps officers has dropped since 1980. For example, 41% of new Marine officers in 2014 would not have met the intelligence standards demanded of officers in World War II. This decline is especially surprising because, as others have documented, 2011 saw the most intelligent group of enlistees in the history of the volunteer military. Thus, even as the intelligence of our enlisted troops have been rising, that of our commissioned officers has been declining.

Why the decrease in officer quality?

We didn’t find it was due to more minorities or women in the ranks, as many have assumed. The basic answer is that more people are going to college. Officers in the volunteer military have always been required to have a four-year college degree. The pool of college students has increased by over 50% since 1980, so these days a lot more Americans meet the key qualification to become an officer than was the case three decades ago. That has been very positive for society by increasing social mobility. But perhaps it hasn’t been all good news. The expansion of the pool of college students means a larger, but lower quality, pool of potential officers. While our data were about Marine officers, the results likely apply to the whole military.

Another example drawn from my experience shows the problems created by a lack of intellectual curiosity. The Afghan Army had several large pictures in their bases and on their trucks of Ahmed Shah Massoud, the famous Tajik warlord who fought against the Soviets. Few of the Marine officers knew his history, but more importantly many others didn’t care to learn. They then couldn’t understand why the local Pashtuns were upset with the presence of “foreign” Tajik troops in their village. Wrongly, we measured success as merely counting the number of Afghan Army patrols, which we took as an indicator of closer relations with the local Pashtuns, without recognizing how the locals truly felt.

Our military is being given increasingly complex and diverse missions across the globe; it doesn’t make sense to train a young officer how to fight against the Soviets in World War III and then ask him or her to be a sociologist and diplomat. But as long as the United States relies on the military to conduct foreign affairs, the military needs to be staffed with knowledgeable, intellectually capable officers.

This decline has not been helped by the anti-military culture that has prevailed at elite universities since the Vietnam War. While Harvard University restored its ROTC program following the repeal of ‘Don’t Ask, Don’t Tell’ in 2011, the continued paucity of cadets there belies their claim that it was always about homosexuals in the military. This year, only *one* cadet was commissioned from Harvard into the Navy — hardly the contribution we would need to create a more intelligent officer corps.

This need for critical thinkers was recognized well before the current wars. In the 1990s, Marine General Charles Krulak wrote of the “Three Block War.” In a single city, the military is conducting humanitarian relief on one block; peacekeeping operations are conducted on the next; and in the third, the troops are engaged in a full-out fight for their lives. Krulak’s prediction was eerily prescient; in Iraq and Afghanistan, we would hand out candy to children on one block, on the next we were trying to solve problems of local governance, and on the third we were walking through a minefield of IEDs.

The military needs intelligent, flexible leaders. We are lacking enough of them right now. As a first step, administer the existing enlisted intelligence test (ASVAB) to all potential officers’ intelligence. After a year of results, establish a minimum score as a short-term solution. In the long-term, we will need to critically evaluate what qualifications produce a successful officer and how we measure those qualifications. The long-term solution will be complicated, but it is vital. Not just for national security, but for the sake of the enlistees who entrust their lives to officers.

New government accounting rules enable local officials to get unfunded obligations to retirees under control.

The budgets of many cities and states will soon be disrupted by new accounting rules for retiree health plans. Local governments pay most of the health-insurance premiums for their retired employees—for example, from age 50 until Medicare at age 65, and sometimes for life. Nationwide, the total unfunded obligations of these plans are close to $1 trillion, according to a comprehensive recent study in the Journal of Health Economics.

The accounting rules, adopted in June by the Government Accounting Standards Board (GASB), require local governments for the first time to report their obligations for retiree health care as liabilities on their balance sheets. Local governments must also use a reasonable and uniform methodology to calculate the present value of these liabilities. These are both steps forward, enhancing transparency and accountability.

The new rules further provide an incentive for local governments to establish a dedicated trust with assets invested today to help pay health-care benefits in the future. But here the GASB takes one step backward, by allowing local governments to make overly optimistic assumptions, including excessive returns for the trust.

Local government health plans for retirees are on average only 6% funded, according to the Pew Charitable Trust. Because most cities pay these health-care costs almost entirely out of current budgets, they increasingly face two unattractive alternatives: raise taxes, or cut spending for such services as schools and police.

However, a handful of cities, such as Los Angeles, prefund their retiree health-care obligations. They contribute considerably more than necessary to pay insurance premiums for current retirees, setting aside and investing assets now to help pay future benefits.

The new GASB rules will encourage local governments to join this prefunding club. Here’s an example of the math. Suppose a city currently reports a $1 billion liability for its retiree health-care obligations, based on an average life of 20 years for benefit payments and a discount rate of 5%. Under the new GASB rules it must use the interest rate on high-quality, tax-exempt bonds with a maturity of 20 years, or 3.3% today. That means the city’s reported liability for retiree health care would increase by 35% to approximately $1.35 billion.

Suppose, instead, the city contributes $100 million to a qualifying trust. The city assumes that the trust’s investments will earn an average annual return of 6%, and that each year it will contribute enough to pay the premiums for current retirees so the trust doesn’t run out of money in the future. Under these conditions, a trust will reduce the city’s unfunded retiree health-care liabilities from $1.35 billion to as low as $750 million.

Forcing cities to report to the public their long-term retiree health-care liabilities—calculated under a reasonable and uniform method—should provoke taxpayers to pressure officials to negotiate less-expensive benefits with the unions. It might also give unions a better sense of the trade-offs between asking for wage increases and higher benefits.

Nevertheless, a word of warning. If a city establishes a trust, taxpayers have to ensure that the government follows through with the necessary annual contributions—and that the government doesn’t hide true health-care liabilities by unrealistic projections of investment returns. As former New York Mayor Michael Bloomberg once said, while assuming a conservative investment portfolio will earn 8% a year is “absolutely hysterical,” reducing it to 7.5% or 7% is merely “totally indefensible.”

New government accounting rules enable local officials to get unfunded obligations to retirees under control.

The budgets of many cities and states will soon be disrupted by new accounting rules for retiree health plans. Local governments pay most of the health-insurance premiums for their retired employees—for example, from age 50 until Medicare at age 65, and sometimes for life. Nationwide, the total unfunded obligations of these plans are close to $1 trillion, according to a comprehensive recent study in the Journal of Health Economics.

The accounting rules, adopted in June by the Government Accounting Standards Board (GASB), require local governments for the first time to report their obligations for retiree health care as liabilities on their balance sheets. Local governments must also use a reasonable and uniform methodology to calculate the present value of these liabilities. These are both steps forward, enhancing transparency and accountability.

The new rules further provide an incentive for local governments to establish a dedicated trust with assets invested today to help pay health-care benefits in the future. But here the GASB takes one step backward, by allowing local governments to make overly optimistic assumptions, including excessive returns for the trust.

Local government health plans for retirees are on average only 6% funded, according to the Pew Charitable Trust. Because most cities pay these health-care costs almost entirely out of current budgets, they increasingly face two unattractive alternatives: raise taxes, or cut spending for such services as schools and police.

However, a handful of cities, such as Los Angeles, prefund their retiree health-care obligations. They contribute considerably more than necessary to pay insurance premiums for current retirees, setting aside and investing assets now to help pay future benefits.

The new GASB rules will encourage local governments to join this prefunding club. Here’s an example of the math. Suppose a city currently reports a $1 billion liability for its retiree health-care obligations, based on an average life of 20 years for benefit payments and a discount rate of 5%. Under the new GASB rules it must use the interest rate on high-quality, tax-exempt bonds with a maturity of 20 years, or 3.3% today. That means the city’s reported liability for retiree health care would increase by 35% to approximately $1.35 billion.

Suppose, instead, the city contributes $100 million to a qualifying trust. The city assumes that the trust’s investments will earn an average annual return of 6%, and that each year it will contribute enough to pay the premiums for current retirees so the trust doesn’t run out of money in the future. Under these conditions, a trust will reduce the city’s unfunded retiree health-care liabilities from $1.35 billion to as low as $750 million.

Forcing cities to report to the public their long-term retiree health-care liabilities—calculated under a reasonable and uniform method—should provoke taxpayers to pressure officials to negotiate less-expensive benefits with the unions. It might also give unions a better sense of the trade-offs between asking for wage increases and higher benefits.

Nevertheless, a word of warning. If a city establishes a trust, taxpayers have to ensure that the government follows through with the necessary annual contributions—and that the government doesn’t hide true health-care liabilities by unrealistic projections of investment returns. As former New York Mayor Michael Bloomberg once said, while assuming a conservative investment portfolio will earn 8% a year is “absolutely hysterical,” reducing it to 7.5% or 7% is merely “totally indefensible.”

Authors

]]>
http://www.brookings.edu/research/opinions/2015/07/24-cadillac-tax-accomplish-repeal-wessel?rssid=economics{7E2C32B4-6E39-46CC-A3D9-D762A0C48075}http://webfeeds.brookings.edu/~/103179672/0/brookingsrss/programs/economics~What-the-%e2%80%98Cadillac-Tax%e2%80%99-accomplishes%e2%80%93and-what-could-be-lost-in-repealWhat the ‘Cadillac Tax’ accomplishes–and what could be lost in repeal

When an employer pays a worker in cash, the worker has to pay income and payroll taxes on the money. When an employer provides or subsidizes health insurance, the worker doesn’t pay taxes on the benefit. This practice, which dates to World War II-era wage-and-price controls, encourages employers to offer more generous health insurance plans as opposed to paying higher wages. It’s one of several reasons the U.S. spends so much more on health care than other rich countries.

To limit the growth of health-care spending, and to help subsidize insurance for low-income Americans, the Affordable Care Act took a step toward limiting this tax break. Beginning Jan. 1, 2018, the law levies a hefty excise tax on health insurance plans worth more than $27,500 per family or $10,200 per individual (with some adjustments to thresholds to be made for hazardous jobs such as those in law enforcement or construction and other factors). This has been dubbed the “Cadillac tax.” (For details, see this Cigna summary or this Health Affairs policy brief.)

So it’s worth looking at why the Cadillac tax was included in the first place and what repealing it would mean.

*Tax incentives that favor health insurance over wages provide an incentive for Americans to spend more on health care than they otherwise would, perhaps more than they need to. Insurance policies that encourage people to use more health care because it’s “free” (with, say, very low co-pays and deductibles) don’t make sense.

*The Cadillac tax is a step toward curbing generous policies while leaving room for tax breaks for policies that provide ample coverage for people when they are really sick. It is meant to encourage employers to increase deductibles and co-pays so people will be better consumers of health care (so Mrs. Clinton has a point). It’s also meant to encourage insurers to scrutinize utilization and to lean on providers. It is imperfect: The threshold, for instance, is national, while health costs vary a lot by region. But that’s true of nearly all thresholds in the tax code. Mortgage interest is deductible on home loans of less than $1 million; that ceiling isn’t adjusted for the variation in housing prices across the country.

*Repealing the Cadillac tax would be a significant setback to efforts to curtail tax breaks and other policies that, while popular, encourage overuse of the health-care system or favor inefficient health-care providers. Tweaking or replacing the tax with an alternative that accomplishes the same goals is a possibility, though finding one that would raise as much money will be hard. Abandoning it would be a worrisome sign that political timidity dooms almost any policy to slow the growth of health-care spending.

*Although politicians and workers are skeptical, economists say that the more employers pay in health insurance benefits, the less they’ll pay in cash wages. When employers look at the cost of labor, they see both wages and benefits. Curbing benefits will tend to increase cash wages, which are taxable. Indeed, a big reason CBO and the Joint Committee on Taxation estimate that the Cadillac tax would yield $87 billion over the next 10 years is that they expect employers to cut back on benefits to avoid the tax and put that money into (taxable) cash wages.

There’s a lot of talk about wringing inefficiency and unnecessary treatment out of the health system as well as shrinking tax loopholes, credits, exclusions, and deductions. The Cadillac tax as written into law won’t accomplish either goal completely. But if it succumbs to the latest round of assaults, the prospects for major legislation on health-care costs or tax reform would be substantially diminished.

Authors

When an employer pays a worker in cash, the worker has to pay income and payroll taxes on the money. When an employer provides or subsidizes health insurance, the worker doesn’t pay taxes on the benefit. This practice, which dates to World War II-era wage-and-price controls, encourages employers to offer more generous health insurance plans as opposed to paying higher wages. It’s one of several reasons the U.S. spends so much more on health care than other rich countries.

To limit the growth of health-care spending, and to help subsidize insurance for low-income Americans, the Affordable Care Act took a step toward limiting this tax break. Beginning Jan. 1, 2018, the law levies a hefty excise tax on health insurance plans worth more than $27,500 per family or $10,200 per individual (with some adjustments to thresholds to be made for hazardous jobs such as those in law enforcement or construction and other factors). This has been dubbed the “Cadillac tax.” (For details, see this Cigna summary or this Health Affairs policy brief.)

So it’s worth looking at why the Cadillac tax was included in the first place and what repealing it would mean.

*Tax incentives that favor health insurance over wages provide an incentive for Americans to spend more on health care than they otherwise would, perhaps more than they need to. Insurance policies that encourage people to use more health care because it’s “free” (with, say, very low co-pays and deductibles) don’t make sense.

*The Cadillac tax is a step toward curbing generous policies while leaving room for tax breaks for policies that provide ample coverage for people when they are really sick. It is meant to encourage employers to increase deductibles and co-pays so people will be better consumers of health care (so Mrs. Clinton has a point). It’s also meant to encourage insurers to scrutinize utilization and to lean on providers. It is imperfect: The threshold, for instance, is national, while health costs vary a lot by region. But that’s true of nearly all thresholds in the tax code. Mortgage interest is deductible on home loans of less than $1 million; that ceiling isn’t adjusted for the variation in housing prices across the country.

*Repealing the Cadillac tax would be a significant setback to efforts to curtail tax breaks and other policies that, while popular, encourage overuse of the health-care system or favor inefficient health-care providers. Tweaking or replacing the tax with an alternative that accomplishes the same goals is a possibility, though finding one that would raise as much money will be hard. Abandoning it would be a worrisome sign that political timidity dooms almost any policy to slow the growth of health-care spending.

*Although politicians and workers are skeptical, economists say that the more employers pay in health insurance benefits, the less they’ll pay in cash wages. When employers look at the cost of labor, they see both wages and benefits. Curbing benefits will tend to increase cash wages, which are taxable. Indeed, a big reason CBO and the Joint Committee on Taxation estimate that the Cadillac tax would yield $87 billion over the next 10 years is that they expect employers to cut back on benefits to avoid the tax and put that money into (taxable) cash wages.

There’s a lot of talk about wringing inefficiency and unnecessary treatment out of the health system as well as shrinking tax loopholes, credits, exclusions, and deductions. The Cadillac tax as written into law won’t accomplish either goal completely. But if it succumbs to the latest round of assaults, the prospects for major legislation on health-care costs or tax reform would be substantially diminished.

Several factors are driving health care providers and facilities, including acute care providers to shift away from prevalent fee-for-service (FFS) payments to value based payment models. Alternate payment models (APMs) are designed to support services that are not traditionally covered under FFS to lead to better coordination of care and higher value care delivery. A move from FFS to APMs requires careful consideration and promulgation of disruptive reforms that encourage more efficient use of existing services, better care coordination, and more effective and efficient acute care while preserving the core functions that acute care facilities provide in their communities. Examples of short-term delivery reforms that can support this transition are creating care plans for high risk patients to help address underlying needs and interoperable health technology to query health records during an acute care episode.

To support a movement away from FFS, a potential range of APMs can be utilized such as partially capitated payments, bundled payment for episodes of acute care, or global budgets with full capitation. These payments require that providers and organizations take on more accountability for the outcomes of their patients, giving them greater flexibility and the potential for higher net revenues from delivering care more efficiently, as well as financial risk if quality metrics are not met and overall cost growth is not slowed. In this paper, we describe several recommendations for moving away from FFS to APMs in acute and emergency care, specifically focused on increasing information sharing, changing payment to incentivize the right delivery reform, and patient engagement. Each category of recommendations presents a long term vision, with several short term implementation steps and examples to achieve this vision.

Several factors are driving health care providers and facilities, including acute care providers to shift away from prevalent fee-for-service (FFS) payments to value based payment models. Alternate payment models (APMs) are designed to support services that are not traditionally covered under FFS to lead to better coordination of care and higher value care delivery. A move from FFS to APMs requires careful consideration and promulgation of disruptive reforms that encourage more efficient use of existing services, better care coordination, and more effective and efficient acute care while preserving the core functions that acute care facilities provide in their communities. Examples of short-term delivery reforms that can support this transition are creating care plans for high risk patients to help address underlying needs and interoperable health technology to query health records during an acute care episode.

To support a movement away from FFS, a potential range of APMs can be utilized such as partially capitated payments, bundled payment for episodes of acute care, or global budgets with full capitation. These payments require that providers and organizations take on more accountability for the outcomes of their patients, giving them greater flexibility and the potential for higher net revenues from delivering care more efficiently, as well as financial risk if quality metrics are not met and overall cost growth is not slowed. In this paper, we describe several recommendations for moving away from FFS to APMs in acute and emergency care, specifically focused on increasing information sharing, changing payment to incentivize the right delivery reform, and patient engagement. Each category of recommendations presents a long term vision, with several short term implementation steps and examples to achieve this vision.

Michiel De Pooter of the Federal Reserve Board, Rebecca DeSimone of Columbia University, Robert F. Martin of Barclays Capital, and Seth Pruitt of Arizona State University find that the European Central Bank's purchase of troubled countries' sovereign debt beginning in 2010 had little to no impact on yields or spreads at the time of purchase, but did have large effects at the time of announcement. This suggests that the ECB's Securities Market Program impacted yields and spreads by raising confidence, rather than through any direct purchase effect.

Pablo Celhay of the University of Chicago, Paul Gertler of the University of California, Berkeley, and Paula Giovagnoli and Christel Vermeersch of The World Bank find that medical clinics that were offered temporary financial incentives to provide first trimester prenatal care were 34% more likely to provide those services, an effect persisting at least 2 years after the incentives expired. This suggests that temporary incentives may be effective in overcoming institutional inertia and improve outcomes at a much lower cost than permanent incentives.

Florence Jaumotte and Carolina Osorio Buitron of the International Monetary Fund find that the decline in unionization and the erosion of minimum wages in advanced economies have been associated with an increase in income inequality. The authors argue that de-unionization can increase inequality by increasing the share of capital income (which tends to be concentrated among higher earners) and by reducing workers' influence on business decisions, including executive compensation.

While financial market participants are particularly focused on the timing of the first rate increase, when it comes to monetary policy, timing isn't everything. The FOMC meets eight times a year, and the difference in lifting off from a zero interest rate a meeting or two earlier or later is not significant. More important for macroeconomic performance is the expected path of policy beyond liftoff because expectations about the future path of policy can affect today’s economic decisions.

—Loretta J. Mester, President and CEO of the Federal Reserve Bank of Cleveland

Glenn Hutchins, vice chair of the Brookings board of trustees and a director of the New York Fed, defends the Fed's structure, including private-sector boards of regional Fed banks, as an "exquisite balance that has served the country so well."

Authors

Michiel De Pooter of the Federal Reserve Board, Rebecca DeSimone of Columbia University, Robert F. Martin of Barclays Capital, and Seth Pruitt of Arizona State University find that the European Central Bank's purchase of troubled countries' sovereign debt beginning in 2010 had little to no impact on yields or spreads at the time of purchase, but did have large effects at the time of announcement. This suggests that the ECB's Securities Market Program impacted yields and spreads by raising confidence, rather than through any direct purchase effect.

Pablo Celhay of the University of Chicago, Paul Gertler of the University of California, Berkeley, and Paula Giovagnoli and Christel Vermeersch of The World Bank find that medical clinics that were offered temporary financial incentives to provide first trimester prenatal care were 34% more likely to provide those services, an effect persisting at least 2 years after the incentives expired. This suggests that temporary incentives may be effective in overcoming institutional inertia and improve outcomes at a much lower cost than permanent incentives.

Florence Jaumotte and Carolina Osorio Buitron of the International Monetary Fund find that the decline in unionization and the erosion of minimum wages in advanced economies have been associated with an increase in income inequality. The authors argue that de-unionization can increase inequality by increasing the share of capital income (which tends to be concentrated among higher earners) and by reducing workers' influence on business decisions, including executive compensation.

While financial market participants are particularly focused on the timing of the first rate increase, when it comes to monetary policy, timing isn't everything. The FOMC meets eight times a year, and the difference in lifting off from a zero interest rate a meeting or two earlier or later is not significant. More important for macroeconomic performance is the expected path of policy beyond liftoff because expectations about the future path of policy can affect today’s economic decisions.

—Loretta J. Mester, President and CEO of the Federal Reserve Bank of Cleveland

Glenn Hutchins, vice chair of the Brookings board of trustees and a director of the New York Fed, defends the Fed's structure, including private-sector boards of regional Fed banks, as an "exquisite balance that has served the country so well."

The trustees of Medicare, four government officials and two private citizens, issue detailed annual reports on the current and projected finances of the Medicare health insurance program for the elderly and disabled. The report, which looks 75 years into the future, incorporates the latest thinking of actuaries on trends in Medicare spending.

What's new in the July 2015 report?

Not much in the near term. The Trustees did make some technical adjustments to their long-run model that lowered projected Medicare spending, but these adjustments only affect the projections from 2041 on. By 2088, this adjustment amounts to a bit less than 1 percent of GDP.

What does the report say about the trajectory of Medicare spending over the next ten years?

Medicare spending is projected to rise from 3.5 percent of GDP in 2014 to 4.3 percent in 2024, with the increase mostly attributable to increased enrollment as the baby boom generation turns 65.

Adjusted for inflation, spending per beneficiary rises an average of just 2% per year—about the same pace as per capita GDP growth—as reimbursement cuts under the Affordable Care Act (ACA) continue to restrain spending.

What about over the long–run?

In the longer run, the Trustees project Medicare spending to increase sharply as a share of the economy, rising from 3.5 percent of GDP in 2014 to 6 percent by 2089.

The rise in spending between 2014 and 2035 is largely driven by increased enrollment. From 2036 to 2089, spending is projected to rise primarily due to growing per-beneficiary costs.

The Medicare problem doesn't look so bad. What happened?

The Trustees have dramatically lowered their projections of long-run Medicare expenditure growth. In 2009, for example, the Trustees projected that Medicare spending would reach 11.2 percent of GDP by 2080—compared with just 6 percent in this year's report. The change in the spending outlook is attributable to the effects of the ACA on provider reimbursements and a much slower rate of increase in actual Medicare expenditures since 2009. Excess cost growth in Medicare—the difference in the growth rates of per beneficiary spending and per capita GDP—is now expected to be quite low relative to historical averages.

So is the Hospital Insurance (Part A) trust fund still projected to be depleted?

Yes, in 2030—the same as in last year's report. Medicare Part A (hospitals) is funded by payroll taxes. Because Medicare enrollment is increasing at a much faster pace than the labor force, even with relatively slow per beneficiary spending growth, outlays are still expected to outpace revenues. Part B of Medicare (doctors) and Part D (drugs) are financed by premiums and by general revenues.

What is the Illustrative Alternative Scenario, and why do the Trustees include it?

The Trustees offer an "illustrative alternative" to their baseline scenario intended to highlight the trajectory of Medicare spending under a hypothetical legislative alternative in which parts of the ACA are repealed. The Affordable Care Act included provisions that lowered the annual increases in provider reimbursements. Before the ACA, payments were to be updated each year by an amount equal to the growth of input costs (hospital wages, etc.); after the ACA, the payment update equals the growth of input costs less the rate of increase in economy-wide productivity. In addition, physician reimbursement updates were cut as part of the recently enacted "doc fix" (the Medicare Access and CHIP Reauthorization Act of 2015). The Trustees believe that, unless the health care sector manages to become much more productive over time, these payments will be too low to ensure that Medicare beneficiaries continue to have good access to health care providers. As a result, they hypothesize that future Congresses might choose to override them. Under this alternative, Medicare spending rises to 9.6% percent of GDP, about 50% higher than in the baseline scenario.

The question of whether the ACA updates are sustainable is a contentious one and depends very much on one's view of health care productivity growth. (For more on this issue, see Louise Sheiner's recent presentation.)

How do the Trustees' estimates compare with CBO's?

The Trustees and CBO have similar projections for spending over the next ten years, but they have very different methodologies for projecting Medicare spending growth in the long run. In particular, the Trustees assume that Medicare spending will rise more slowly than private health expenditures, while CBO assumes that Medicare spending will rise more rapidly. As a result, their projections diverge sharply as the horizon is extended, with CBO projecting Medicare expenditures to be more than twice as high as a share of GDP by 2089.

How much stock should I put into any of these long-term projections?

Not much after the first ten years or so. Long-term projections are inherently uncertain, and healthcare spending is particularly difficult to predict. Whether or not the recent slowdown in health expenditures will persist, the pace of technological progress in the medical field, and the effectiveness of the Affordable Care Act's cost-saving measures can all have large impacts on long-run medical spending, but are nearly impossible to accurately predict. The wide differences between the Trustees' and CBO's projections highlight the enormous uncertainty of long-term health spending projections.

Who are the Trustees and how do they get appointed?

The board of trustees is a six-member body made up of four government officials—Treasury Secretary Jack Lew, Labor Secretary Thomas Perez, Health and Human Services Secretary Sylvia Mathews Burwell, and Acting Commissioner of Social Security Carolyn Colvin—along with two trustees appointed by the President and confirmed by the Senate as representatives of the public—Charles P. Blahous III and Robert D. Reischauer.

Authors

The trustees of Medicare, four government officials and two private citizens, issue detailed annual reports on the current and projected finances of the Medicare health insurance program for the elderly and disabled. The report, which looks 75 years into the future, incorporates the latest thinking of actuaries on trends in Medicare spending.

What's new in the July 2015 report?

Not much in the near term. The Trustees did make some technical adjustments to their long-run model that lowered projected Medicare spending, but these adjustments only affect the projections from 2041 on. By 2088, this adjustment amounts to a bit less than 1 percent of GDP.

What does the report say about the trajectory of Medicare spending over the next ten years?

Medicare spending is projected to rise from 3.5 percent of GDP in 2014 to 4.3 percent in 2024, with the increase mostly attributable to increased enrollment as the baby boom generation turns 65.

Adjusted for inflation, spending per beneficiary rises an average of just 2% per year—about the same pace as per capita GDP growth—as reimbursement cuts under the Affordable Care Act (ACA) continue to restrain spending.

What about over the long–run?

In the longer run, the Trustees project Medicare spending to increase sharply as a share of the economy, rising from 3.5 percent of GDP in 2014 to 6 percent by 2089.

The rise in spending between 2014 and 2035 is largely driven by increased enrollment. From 2036 to 2089, spending is projected to rise primarily due to growing per-beneficiary costs.

The Medicare problem doesn't look so bad. What happened?

The Trustees have dramatically lowered their projections of long-run Medicare expenditure growth. In 2009, for example, the Trustees projected that Medicare spending would reach 11.2 percent of GDP by 2080—compared with just 6 percent in this year's report. The change in the spending outlook is attributable to the effects of the ACA on provider reimbursements and a much slower rate of increase in actual Medicare expenditures since 2009. Excess cost growth in Medicare—the difference in the growth rates of per beneficiary spending and per capita GDP—is now expected to be quite low relative to historical averages.

So is the Hospital Insurance (Part A) trust fund still projected to be depleted?

Yes, in 2030—the same as in last year's report. Medicare Part A (hospitals) is funded by payroll taxes. Because Medicare enrollment is increasing at a much faster pace than the labor force, even with relatively slow per beneficiary spending growth, outlays are still expected to outpace revenues. Part B of Medicare (doctors) and Part D (drugs) are financed by premiums and by general revenues.

What is the Illustrative Alternative Scenario, and why do the Trustees include it?

The Trustees offer an "illustrative alternative" to their baseline scenario intended to highlight the trajectory of Medicare spending under a hypothetical legislative alternative in which parts of the ACA are repealed. The Affordable Care Act included provisions that lowered the annual increases in provider reimbursements. Before the ACA, payments were to be updated each year by an amount equal to the growth of input costs (hospital wages, etc.); after the ACA, the payment update equals the growth of input costs less the rate of increase in economy-wide productivity. In addition, physician reimbursement updates were cut as part of the recently enacted "doc fix" (the Medicare Access and CHIP Reauthorization Act of 2015). The Trustees believe that, unless the health care sector manages to become much more productive over time, these payments will be too low to ensure that Medicare beneficiaries continue to have good access to health care providers. As a result, they hypothesize that future Congresses might choose to override them. Under this alternative, Medicare spending rises to 9.6% percent of GDP, about 50% higher than in the baseline scenario.

The question of whether the ACA updates are sustainable is a contentious one and depends very much on one's view of health care productivity growth. (For more on this issue, see Louise Sheiner's recent presentation.)

How do the Trustees' estimates compare with CBO's?

The Trustees and CBO have similar projections for spending over the next ten years, but they have very different methodologies for projecting Medicare spending growth in the long run. In particular, the Trustees assume that Medicare spending will rise more slowly than private health expenditures, while CBO assumes that Medicare spending will rise more rapidly. As a result, their projections diverge sharply as the horizon is extended, with CBO projecting Medicare expenditures to be more than twice as high as a share of GDP by 2089.

How much stock should I put into any of these long-term projections?

Not much after the first ten years or so. Long-term projections are inherently uncertain, and healthcare spending is particularly difficult to predict. Whether or not the recent slowdown in health expenditures will persist, the pace of technological progress in the medical field, and the effectiveness of the Affordable Care Act's cost-saving measures can all have large impacts on long-run medical spending, but are nearly impossible to accurately predict. The wide differences between the Trustees' and CBO's projections highlight the enormous uncertainty of long-term health spending projections.

Who are the Trustees and how do they get appointed?

The board of trustees is a six-member body made up of four government officials—Treasury Secretary Jack Lew, Labor Secretary Thomas Perez, Health and Human Services Secretary Sylvia Mathews Burwell, and Acting Commissioner of Social Security Carolyn Colvin—along with two trustees appointed by the President and confirmed by the Senate as representatives of the public—Charles P. Blahous III and Robert D. Reischauer.

You have before you a long list of proposed legislative changes applying to the Federal Reserve, some of which would make important changes in the character of the institution, its policy processes, and its authorities. At the same time you are also considering the formation of a commission to examine whether indeed the Federal Reserve should be altered to make it a more effective institution. The basic premise of both of these strands is that something has been seriously amiss with the way the Federal Reserve has carried out the responsibilities Congress has given it.

I do not agree with that premise. In my view, the actions of the Federal Reserve in the crisis and slow recovery were necessary and appropriate. Its conduct of monetary policy has been as systematic as possible under unprecedented and constantly evolving circumstances, and it has been especially transparent about how those monetary policy actions were expected to foster achievement of its legislated mandate and what it would be looking at in the future to gauge the need for future actions. The Federal Reserve, working in part under the guidance of the Congress in Dodd Frank, has greatly toughened and improved its regulation and supervision of the institutions for which it is responsible, and the financial system is safer than it has been for many years.

No institution is perfect. Circumstances change, lessons are learned, and all policy institutions must adapt if they are to continue to serve the public interest as well as possible. You are right to be asking tough questions about whether further improvements in the Federal Reserve’s performance as well as your oversight and the Fed’s accountability are possible, and the extent to which new legislation is needed to make those changes. In my view, however, the suggestions in the proposed legislation, as I weigh their costs and benefits, are not likely to improve the Federal Reserve’s performance and enhance the public interest, and could very well harm it.

Congress has established goals for monetary policy, given the experts at the Federal Reserve insulation from short-term political pressures to set their policy instruments to meet those goals, and then held the Federal Reserve accountable for the outcomes. The Senate, in its role in appointments to the Federal Reserve Board, has a critical say in making sure the right experts are in place to carry out this responsibility. You have recognized that this model of independent but accountable central banking has proven to work better in the public interest than one in which political pressures can be brought more forcefully to bear on the central bank instrument settings. I urge you to keep the current balance in place.

Let me address just a few of the proposals.

Policy Rules and GAOaudits. Being as systematic, predictable, and transparent as possible about what the Federal Reserve is doing increases the effectiveness of monetary policy because it helps private market participants accurately anticipate Federal Reserve actions. It also enhances your ability to assess the policy strategies of the FOMC. The Federal Reserve should explain why it has chosen the instrument settings it has, how those settings are expected to foster achievement of their responsibilities, and on what basis they might evolve in the future. The FOMC has taken a number of steps to increase the predictability and transparency of its actions, especially over the past 10 years.

But “as possible” is the key phrase in that first sentence of the previous paragraph. The Federal Reserve, the Congress, and private market participants must recognize the limits of our knowledge of economic relationships, including the relationship between changes in policy instrument settings and progress toward the Federal Reserve’s legislated objectives. The U.S. economy is a complex and ever-changing system that cannot be comprehensively summarized in a few variables and empirical relationships. Not only are the relationships imperfectly understood and evolving, but unexpected developments here and around the world can affect the U.S. economy.

The result is that the Federal Reserve must use all available information that might shed light on evolving economic relationships and the effects of policy, and use it in a flexible manner. Statistical economic models relating future inflation, economic activity, and labor market slack to incoming information about the economy and to financial variables have proven especially unreliable over the past eight years of financial market disruption; history has been a poor guide to the future in these unprecedented circumstances. Models and policy rules can be useful inputs for policy, but they are only inputs and cannot be relied on as hard guides to policy settings to achieve the Federal Reserve’s objectives.

To be sure, policy has taken unexpected steps over the past seven years, but this was in response to unexpected developments. Moreover, the recovery from the financial crisis was disappointingly slow. But it would have been even slower had the FOMC not undertaken unconventional and sometimes unexpected policy actions. The pricing of actual and expected volatility in financial markets has not suggested an unusual amount of uncertainty about the path of interest rates or the Federal Reserve’s portfolio holdings going forward.

Requiring the Federal Reserve to send you a rule that includes “a function that comprehensively models the interactive relationship between intermediate policy inputs” and “the coefficients of the directive policy rule that generate the current policy instrument target” would be at best a useless exercise for you, the Federal Reserve, and the American public and could well prove counterproductive for achieving goals and understanding strategies. If it is adhered to it will produce inferior results; if it is not, as I would hope and expect, it would be misleading.

If the Federal Reserve were to frequently alter and deviate from policy rules you would require it to publish under the proposal, as I expect it would, then the GAO would be frequently second guessing FOMC decisions. Indeed, under another section of the proposed legislation the exemption for monetary policy from GAO audit would be repealed.

Congress was wise to differentiate monetary policy from other functions of the Federal Reserve in 1978 when it authorized GAO audits of those other functions. It recognized that the GAO audits could become an avenue for bringing political pressure on the FOMC’s decisions on the setting of its policy instruments. Around the same time, Congress clarified the objectives for policy and it established reports and hearings to hold the Federal Reserve accountable for achieving those objectives. It also recognized that over time and across countries, experience suggested that when monetary policy is subject to short-term political pressures, outcomes are inferior; in particular inflation tends to be higher and more variable.

In that context, the extra pressure of GAO audits of policy decisions moves the needle in the wrong direction. At some point, and I hope before too long, the labor market will be strong enough and the prospects for inflation to rise will be good enough that the Federal Reserve will begin to tighten policy to avoid overshooting its two percent inflation target. That will not be popular with some political observers. The Congress made a good decision in 1978 and I urge you to stick with it and find other ways to inform your oversight of monetary policy.

Changes to emergency lending powers for nonbanks. Supplying liquidity to financial institutions by lending against possibly illiquid collateral is a key function of central banks. Indeed, having an institution to do this in the U.S. was a major impetus behind Congress establishing the Federal Reserve in 1913. When confidence in financial institutions erodes and uncertainty about whether they can repay the funds they borrowed increases, they experience runs—those supplying funds to banks and other intermediaries stop. Without a backup source of funding, lenders are forced to stop making loans and to sell assets in the market at any price. The resulting drying up of credit and fire sale of assets severely harms the ability of households and businesses to borrow and spend and can result in deep recessions with high unemployment. Borrowing from a central bank under such circumstances helps lenders continue to meet the credit needs of households and businesses; it is an essential way for the central bank to cushion Main Street from the loss of confidence in the financial sector.

For most of the twentieth century the Federal Reserve could perform that function adequately by lending to commercial banks and other depositories. But in the past few decades, intermediation in the U.S. has shifted from banks to securities and securitization markets. In 2008, the Federal Reserve found that lending to nonbanks—to investment banks, money market funds, buyers of securitizations—was required to stem the panic and limit the damage to Main Street. Some of what we did, however necessary, was uncomfortable—in particular lending to support individual troubled institutions, like AIG, or to support of the acquisition of Bear Stearns. The Federal Reserve supported giving the FDIC an alternative method of dealing with troubled financial institutions and limiting the use of the discount window for nonbanks to facilities that would be widely available to institutions caught up in the panic.

Congress made those changes on lending to nonbanks in Dodd-Frank and added a few more on reporting, collateral, and approval by the secretary of the Treasury. I would not go further; in fact I’m concerned that some of what you have already done might limit the effectiveness of the Federal Reserve’s lender of last resort function for a twenty-first century financial market—make panics even harder to stop and raise the risk that households and businesses would lose access to credit. The restrictions you have already placed on 13-3 lending, the resolution authority you have given to the FDIC, and the higher capital requirements on systemically important institutions are in the process of eliminating the moral hazard of any remaining perceived benefit from nonbank access to lender of last resort.

We need to keep in mind that difficult judgments are required in such a situation—especially about solvency and collateral valuations. The nature of a financial crisis is that the line between liquidity problems and solvency problems is not clear—institutions that might be insolvent if their assets were sold at fire sale prices might be comfortably solvent when the panic subsides; collateral whose value has dropped sharply in the panic will recover as the panic subsides. Central banks need to be able to make such judgment calls quickly—and explain them to the public—and they need to be sure not to add to market problems by chasing collateral values down or judging otherwise sound institutions as insolvent.

The Monetary Commission. As I said at the beginning of my testimony, no institution is perfect; all need to learn lessons and adapt. The Federal Reserve has been adapting its monetary policy strategy and communications. The Federal Reserve, the other regulators, and the Congress have addressed many of the deficiencies in regulation and supervision that allowed the circumstances that led to the crisis to build.

As I also noted, I do not believe that major changes have been identified that would make the Federal Reserve a significantly more effective public policy institution. But I recognize that the geographical structure of the System was set in 1914; some of the relationships among its constituent parts, including the make-up of the monetary policy committee, in the 1930s; and its monetary policy goals and reporting in the late 1970s. I cannot rule out that a group of thoughtful policy experts might be able to suggest some further improvements to goals, structure, and decision-making processes.

But the proposal before us has a panel rooted in partisan politics, not expertise, and its make-up is strongly tilted to one side. It has in effect pre-judged one aspect of the conclusions by mandating that a reserve bank president be included, but not a member of the board of governors. Shifting authority from the Board to the presidents is a general theme of many of the proposals before us and as a citizen I find it troubling. The reserve banks and their presidents make valuable contributions to the policy process; in particular they bring a greater diversity of views than is often found on the board of governors. But they are selected by private boards of directors, to be sure with the approval of the board of governors, and giving them greater authority would in my view threaten the perceived democratic legitimacy of the Federal Reserve over time.

The Congress has given the Federal Reserve Board, with its members appointed by the president and approved by the senate, a clear majority on the FOMC, even when there might be a vacancy on the Board. And it has given the Board authority over discount window lending by the reserve banks as well as their operations. I believe that public support for the Federal Reserve in our democratic society requires that the authority of the Board not be eroded.

Authors

You have before you a long list of proposed legislative changes applying to the Federal Reserve, some of which would make important changes in the character of the institution, its policy processes, and its authorities. At the same time you are also considering the formation of a commission to examine whether indeed the Federal Reserve should be altered to make it a more effective institution. The basic premise of both of these strands is that something has been seriously amiss with the way the Federal Reserve has carried out the responsibilities Congress has given it.

I do not agree with that premise. In my view, the actions of the Federal Reserve in the crisis and slow recovery were necessary and appropriate. Its conduct of monetary policy has been as systematic as possible under unprecedented and constantly evolving circumstances, and it has been especially transparent about how those monetary policy actions were expected to foster achievement of its legislated mandate and what it would be looking at in the future to gauge the need for future actions. The Federal Reserve, working in part under the guidance of the Congress in Dodd Frank, has greatly toughened and improved its regulation and supervision of the institutions for which it is responsible, and the financial system is safer than it has been for many years.

No institution is perfect. Circumstances change, lessons are learned, and all policy institutions must adapt if they are to continue to serve the public interest as well as possible. You are right to be asking tough questions about whether further improvements in the Federal Reserve’s performance as well as your oversight and the Fed’s accountability are possible, and the extent to which new legislation is needed to make those changes. In my view, however, the suggestions in the proposed legislation, as I weigh their costs and benefits, are not likely to improve the Federal Reserve’s performance and enhance the public interest, and could very well harm it.

Congress has established goals for monetary policy, given the experts at the Federal Reserve insulation from short-term political pressures to set their policy instruments to meet those goals, and then held the Federal Reserve accountable for the outcomes. The Senate, in its role in appointments to the Federal Reserve Board, has a critical say in making sure the right experts are in place to carry out this responsibility. You have recognized that this model of independent but accountable central banking has proven to work better in the public interest than one in which political pressures can be brought more forcefully to bear on the central bank instrument settings. I urge you to keep the current balance in place.

Let me address just a few of the proposals.

Policy Rules and GAOaudits. Being as systematic, predictable, and transparent as possible about what the Federal Reserve is doing increases the effectiveness of monetary policy because it helps private market participants accurately anticipate Federal Reserve actions. It also enhances your ability to assess the policy strategies of the FOMC. The Federal Reserve should explain why it has chosen the instrument settings it has, how those settings are expected to foster achievement of their responsibilities, and on what basis they might evolve in the future. The FOMC has taken a number of steps to increase the predictability and transparency of its actions, especially over the past 10 years.

But “as possible” is the key phrase in that first sentence of the previous paragraph. The Federal Reserve, the Congress, and private market participants must recognize the limits of our knowledge of economic relationships, including the relationship between changes in policy instrument settings and progress toward the Federal Reserve’s legislated objectives. The U.S. economy is a complex and ever-changing system that cannot be comprehensively summarized in a few variables and empirical relationships. Not only are the relationships imperfectly understood and evolving, but unexpected developments here and around the world can affect the U.S. economy.

The result is that the Federal Reserve must use all available information that might shed light on evolving economic relationships and the effects of policy, and use it in a flexible manner. Statistical economic models relating future inflation, economic activity, and labor market slack to incoming information about the economy and to financial variables have proven especially unreliable over the past eight years of financial market disruption; history has been a poor guide to the future in these unprecedented circumstances. Models and policy rules can be useful inputs for policy, but they are only inputs and cannot be relied on as hard guides to policy settings to achieve the Federal Reserve’s objectives.

To be sure, policy has taken unexpected steps over the past seven years, but this was in response to unexpected developments. Moreover, the recovery from the financial crisis was disappointingly slow. But it would have been even slower had the FOMC not undertaken unconventional and sometimes unexpected policy actions. The pricing of actual and expected volatility in financial markets has not suggested an unusual amount of uncertainty about the path of interest rates or the Federal Reserve’s portfolio holdings going forward.

Requiring the Federal Reserve to send you a rule that includes “a function that comprehensively models the interactive relationship between intermediate policy inputs” and “the coefficients of the directive policy rule that generate the current policy instrument target” would be at best a useless exercise for you, the Federal Reserve, and the American public and could well prove counterproductive for achieving goals and understanding strategies. If it is adhered to it will produce inferior results; if it is not, as I would hope and expect, it would be misleading.

If the Federal Reserve were to frequently alter and deviate from policy rules you would require it to publish under the proposal, as I expect it would, then the GAO would be frequently second guessing FOMC decisions. Indeed, under another section of the proposed legislation the exemption for monetary policy from GAO audit would be repealed.

Congress was wise to differentiate monetary policy from other functions of the Federal Reserve in 1978 when it authorized GAO audits of those other functions. It recognized that the GAO audits could become an avenue for bringing political pressure on the FOMC’s decisions on the setting of its policy instruments. Around the same time, Congress clarified the objectives for policy and it established reports and hearings to hold the Federal Reserve accountable for achieving those objectives. It also recognized that over time and across countries, experience suggested that when monetary policy is subject to short-term political pressures, outcomes are inferior; in particular inflation tends to be higher and more variable.

In that context, the extra pressure of GAO audits of policy decisions moves the needle in the wrong direction. At some point, and I hope before too long, the labor market will be strong enough and the prospects for inflation to rise will be good enough that the Federal Reserve will begin to tighten policy to avoid overshooting its two percent inflation target. That will not be popular with some political observers. The Congress made a good decision in 1978 and I urge you to stick with it and find other ways to inform your oversight of monetary policy.

Changes to emergency lending powers for nonbanks. Supplying liquidity to financial institutions by lending against possibly illiquid collateral is a key function of central banks. Indeed, having an institution to do this in the U.S. was a major impetus behind Congress establishing the Federal Reserve in 1913. When confidence in financial institutions erodes and uncertainty about whether they can repay the funds they borrowed increases, they experience runs—those supplying funds to banks and other intermediaries stop. Without a backup source of funding, lenders are forced to stop making loans and to sell assets in the market at any price. The resulting drying up of credit and fire sale of assets severely harms the ability of households and businesses to borrow and spend and can result in deep recessions with high unemployment. Borrowing from a central bank under such circumstances helps lenders continue to meet the credit needs of households and businesses; it is an essential way for the central bank to cushion Main Street from the loss of confidence in the financial sector.

For most of the twentieth century the Federal Reserve could perform that function adequately by lending to commercial banks and other depositories. But in the past few decades, intermediation in the U.S. has shifted from banks to securities and securitization markets. In 2008, the Federal Reserve found that lending to nonbanks—to investment banks, money market funds, buyers of securitizations—was required to stem the panic and limit the damage to Main Street. Some of what we did, however necessary, was uncomfortable—in particular lending to support individual troubled institutions, like AIG, or to support of the acquisition of Bear Stearns. The Federal Reserve supported giving the FDIC an alternative method of dealing with troubled financial institutions and limiting the use of the discount window for nonbanks to facilities that would be widely available to institutions caught up in the panic.

Congress made those changes on lending to nonbanks in Dodd-Frank and added a few more on reporting, collateral, and approval by the secretary of the Treasury. I would not go further; in fact I’m concerned that some of what you have already done might limit the effectiveness of the Federal Reserve’s lender of last resort function for a twenty-first century financial market—make panics even harder to stop and raise the risk that households and businesses would lose access to credit. The restrictions you have already placed on 13-3 lending, the resolution authority you have given to the FDIC, and the higher capital requirements on systemically important institutions are in the process of eliminating the moral hazard of any remaining perceived benefit from nonbank access to lender of last resort.

We need to keep in mind that difficult judgments are required in such a situation—especially about solvency and collateral valuations. The nature of a financial crisis is that the line between liquidity problems and solvency problems is not clear—institutions that might be insolvent if their assets were sold at fire sale prices might be comfortably solvent when the panic subsides; collateral whose value has dropped sharply in the panic will recover as the panic subsides. Central banks need to be able to make such judgment calls quickly—and explain them to the public—and they need to be sure not to add to market problems by chasing collateral values down or judging otherwise sound institutions as insolvent.

The Monetary Commission. As I said at the beginning of my testimony, no institution is perfect; all need to learn lessons and adapt. The Federal Reserve has been adapting its monetary policy strategy and communications. The Federal Reserve, the other regulators, and the Congress have addressed many of the deficiencies in regulation and supervision that allowed the circumstances that led to the crisis to build.

As I also noted, I do not believe that major changes have been identified that would make the Federal Reserve a significantly more effective public policy institution. But I recognize that the geographical structure of the System was set in 1914; some of the relationships among its constituent parts, including the make-up of the monetary policy committee, in the 1930s; and its monetary policy goals and reporting in the late 1970s. I cannot rule out that a group of thoughtful policy experts might be able to suggest some further improvements to goals, structure, and decision-making processes.

But the proposal before us has a panel rooted in partisan politics, not expertise, and its make-up is strongly tilted to one side. It has in effect pre-judged one aspect of the conclusions by mandating that a reserve bank president be included, but not a member of the board of governors. Shifting authority from the Board to the presidents is a general theme of many of the proposals before us and as a citizen I find it troubling. The reserve banks and their presidents make valuable contributions to the policy process; in particular they bring a greater diversity of views than is often found on the board of governors. But they are selected by private boards of directors, to be sure with the approval of the board of governors, and giving them greater authority would in my view threaten the perceived democratic legitimacy of the Federal Reserve over time.

The Congress has given the Federal Reserve Board, with its members appointed by the president and approved by the senate, a clear majority on the FOMC, even when there might be a vacancy on the Board. And it has given the Board authority over discount window lending by the reserve banks as well as their operations. I believe that public support for the Federal Reserve in our democratic society requires that the authority of the Board not be eroded.